Item 8. Financial Statements and Supplementary Data.

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Item 8. Financial Statements and Supplementary Data.

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CONSOLIDATED BALANCE SHEETS

as of December 31 (in millions, except share information)		2016			2015
Current assets	Cash and equivalents	$	2,801		$	2,213
	Accounts and other current receivables, net		1,691			1,731
	Inventories		1,430			1,604
	Prepaid expenses and other		602			855
	Investment in Baxalta common stock		—			5,148
	Current assets held for disposition		50			245
	Total current assets		6,574			11,796
Property, plant and equipment, net			4,289			4,386
Other assets	Goodwill		2,595			2,687
	Other intangible assets, net		1,111			1,349
	Other		977			744
	Total other assets		4,683			4,780
	Total assets	$	15,546		$	20,962
Current liabilities	Short-term debt	$	—		$	1,775
	Current maturities of long-term debt and lease obligations		3			810
	Accounts payable and accrued liabilities		2,612			2,666
	Current income taxes payable		126			453
	Current liabilities held for disposition		3			46
	Total current liabilities		2,744			5,750
Long-term debt and lease obligations			2,779			3,922
Other long-term liabilities			1,743			2,425
Equity	Common stock, $1 par value, authorized 2,000,000,000 shares, issued 683,494,944 shares in 2016 and 2015		683			683
	Common stock in treasury, at cost, 143,890,064 shares in 2016 and 135,839,938 shares in 2015		(7,995	)		(7,646	)
	Additional contributed capital		5,958			5,902
	Retained earnings		14,200			9,683
	Accumulated other comprehensive (loss) income		(4,556	)		224
	Total Baxter shareholders’ equity		8,290			8,846
	Noncontrolling interests		(10	)		19
	Total equity		8,280			8,865
	Total liabilities and equity	$	15,546		$	20,962

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF INCOME

years ended December 31 (in millions, except per share data)	2016			2015			2014
Net sales	$	10,163		$	9,968		$	10,719
Cost of sales		6,053			5,822			6,138
Gross margin		4,110			4,146			4,581
Marketing and administrative expenses		2,739			3,094			3,315
Research and development expenses		647			603			610
Operating income		724			449			656
Net interest expense		66			126			145
Other (income) expense, net		(4,296	)		(105	)		21
Income from continuing operations before income taxes		4,954			428			490
Income tax (benefit) expense		(12	)		35			33
Income from continuing operations		4,966			393			457
(Loss) income from discontinued operations, net of tax		(1	)		575			2,040
Net income	$	4,965		$	968		$	2,497
Income from continuing operations per common share
Basic	$	9.10		$	0.72		$	0.84
Diluted	$	9.01		$	0.72		$	0.83
(Loss) income from discontinued operations per common share
Basic	$	(0.01	)	$	1.06		$	3.77
Diluted	$	0.00		$	1.04		$	3.73
Net income per common share
Basic	$	9.09		$	1.78		$	4.61
Diluted	$	9.01		$	1.76		$	4.56
Weighted-average number of common shares outstanding
Basic		546			545			542
Diluted		551			549			547

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

years ended December 31 (in millions)	2016			2015			2014
Net income	$	4,965		$	968		$	2,497
Other comprehensive (loss) income, net of tax:
Currency translation adjustments, net of tax benefit of ($39) in 2016, ($107) in 2015 and ($132) in 2014		(247	)		(1,094	)		(1,332	)
Pension and other employee benefits, net of tax (benefit) expense of ($36) in 2016, $104 in 2015 and ($193) in 2014		(97	)		165			(400	)
Hedging activities, net of tax (benefit) expense of ($2) in 2016, $9 in 2015 and $14 in 2014		(4	)		15			24
Available-for-sale securities, net of tax expense (benefit) of zero in 2016, $6 in 2015 and ($2) in 2014		(4,432	)		4,438			34
Total other comprehensive income (loss), net of tax		(4,780	)		3,524			(1,674	)
Comprehensive income	$	185		$	4,492		$	823

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

years ended December 31 (in millions) (brackets denote cash outflows)		2016			2015			2014
Cash flows from	Net income	$	4,965		$	968		$	2,497
operations	Adjustments to reconcile income from continuing operations to net cash from operating activities:
	Loss (income) from discontinued operations, net of tax		1			(575	)		(2,040	)
	Depreciation and amortization		800			759			792
	Deferred income taxes		(302	)		(50	)		(117	)
	Stock compensation		115			126			126
	Realized excess tax benefits from stock issued under employee benefit plans		(39	)		(7	)		(15	)
	Net periodic pension benefit and OPEB costs		116			227			219
	Business optimization items		285			130			(6	)
	Net realized gains on Baxalta common stock		(4,387	)		—			—
	Infusion pump and other product-related charges		(18	)		(28	)		93
	Other		264			42			19
	Changes in balance sheet items
	Accounts and other current receivables, net		15			(4	)		(93	)
	Inventories		80			(118	)		(143	)
	Accounts payable and accrued liabilities		(197	)		236			(37	)
	Business optimization and infusion pump payments		(189	)		(112	)		(124	)
	Other		115			(341	)		(17	)
	Cash flows from operations – continuing operations		1,624			1,253			1,154
	Cash flows from operations – discontinued operations		30			518			2,061
	Cash flows from operations		1,654			1,771			3,215
Cash flows from	Capital expenditures		(719	)		(911	)		(925	)
investing activities	Acquisitions and investments, net of cash acquired		(48	)		(34	)		(95	)
	Divestitures and other investing activities		37			84			99
	Cash flows from investing activities – continuing operations		(730	)		(861	)		(921	)
	Cash flows from investing activities – discontinued operations		15			(946	)		(621	)
	Cash flows from investing activities		(715	)		(1,807	)		(1,542	)
Cash flows from	Issuances of debt		1,641			6,868			41
financing activities	Payments of obligations		(1,381	)		(3,786	)		(1,029	)
	Debt extinguishment costs		(16	)		(114	)		—
	(Decrease) increase in debt with original maturities of three months or less, net		(300	)		(575	)		875
	Transfer of cash and equivalents to Baxalta		—			(2,122	)		—
	Cash dividends on common stock		(268	)		(910	)		(1,095	)
	Proceeds and realized excess tax benefits from stock issued under employee benefit plans		325			200			369
	Purchases of treasury stock		(292	)		—			(550	)
	Other		(33	)		(42	)		(13	)
	Cash flows from financing activities		(324	)		(481	)		(1,402	)
Effect of foreign exchange rate changes on cash and equivalents			(27	)		(195	)		(79	)
Increase (decrease) in cash and equivalents			588			(712	)		192
Cash and equivalents at beginning of year			2,213			2,925			2,733
Cash and equivalents at end of year		$	2,801		$	2,213		$	2,925
Supplemental schedule of non-cash investing and financing activities
Net proceeds on Retained Shares transactions		$	4,387		$	—		$	—
Payment of obligations in exchange for Retained Shares		$	3,646		$	—		$	—
Exchange of Baxter shares with Retained Shares		$	611		$	—		$	—
Other supplemental information
Interest paid, net of portion capitalized		$	99		$	178		$	208
Income taxes paid		$	500		$	466		$	726

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

	2016						2015						2014
as of and for the years ended December 31 (in millions)	Shares			Amount			Shares			Amount			Shares			Amount
Common stock
Balance, beginning and end of year		683		$	683			683		$	683			683		$	683
Common stock in treasury
Beginning of year		136			(7,646	)		141			(7,993	)		140			(7,914	)
Purchases of common stock		18			(902	)		—			—			8			(550	)
Stock issued under employee benefit plans and other		(10	)		553			(5	)		347			(7	)		471
End of year		144			(7,995	)		136			(7,646	)		141			(7,993	)
Additional contributed capital
Beginning of year					5,902						5,853						5,818
Stock issued under employee benefit plans and other					43						49						35
Other					13						—						—
End of year					5,958						5,902						5,853
Retained earnings
Beginning of year					9,683						13,227						11,852
Net income					4,965						968						2,497
Dividends declared on common stock					(276	)					(695	)					(1,116	)
Stock issued under employee benefit plans					(190	)					(90	)					(6	)
Distribution of Baxalta					18						(3,727	)					—
End of year					14,200						9,683						13,227
Accumulated other comprehensive income (loss)
Beginning of year					224						(3,650	)					(1,976	)
Other comprehensive income (loss)					(4,780	)					3,524						(1,674	)
Distribution of Baxalta					—						350						—
End of year					(4,556	)					224						(3,650	)
Total Baxter shareholders’ equity				$	8,290					$	8,846					$	8,120
Noncontrolling interests
Beginning of year				$	19					$	36					$	23
Change in noncontrolling interests					(29	)					(17	)					13
End of year				$	(10	)				$	19					$	36
Total equity				$	8,280					$	8,865					$	8,156

The accompanying notes are an integral part of these consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Baxter International Inc., through its subsidiaries, provides a broad portfolio of essential renal and hospital products, including acute and chronic dialysis; sterile IV solutions; infusion systems and devices; parenteral nutrition therapies; premixed and oncolytic injectables; biosurgery products and anesthetics; drug reconstitution systems; and pharmacy automation, software and services. The company’s global footprint and the critical nature of its products and services play a key role in expanding access to healthcare in emerging and developed countries. These products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors’ offices and by patients at home under physician supervision. The company operates in two segments, Renal and Hospital Products, which are described in Note 17.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles (GAAP) requires the company to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates.

Basis of Presentation

The consolidated financial statements include the accounts of Baxter and its majority-owned subsidiaries that Baxter controls, after elimination of intercompany transactions.

On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of Baxalta Incorporated (Baxalta), to Baxter shareholders (the Distribution). The Distribution was made to Baxter’s shareholders of record as of the close of business on June 17, 2015 (the Record Date), who received one share of Baxalta common stock for each Baxter common share held as of the Record Date. As a result of the Distribution, Baxalta became an independent public company trading under the symbol “BXLT” on the New York Stock Exchange.

In 2016, Baxter disposed of its remaining 19.5% interest in Baxalta through a series of transactions including debt-for-equity exchanges, an equity-for-equity exchange and a contribution to its U.S. pension plan. As a result of these transactions, the company extinguished approximately $3.65 billion in company indebtedness, repurchased 11,526,638 Baxter shares and contributed 17,145,570 Baxalta shares to its U.S. pension plan. On June 3, 2016, Baxalta became a wholly-owned subsidiary of Shire plc (Shire).

References in this report to Baxalta prior to the Merger closing date refers to Baxalta as a stand-alone public company. References in this report to Baxalta subsequent to the Merger closing date refer to Baxalta as a subsidiary of Shire.

As a result of the separation, the consolidated statements of income, consolidated balance sheets, consolidated statements of cash flow, and related financial information reflect Baxalta’s operations, assets and liabilities, and cash flows as discontinued operations for all periods presented. Refer to Note 2 for additional information regarding the separation of Baxalta.

Revenue Recognition

The company recognizes revenues from product sales and services when earned. Specifically, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable, and collectability is reasonably assured. For product sales, revenue is not recognized until title and risk of loss have transferred to the customer. The shipping terms for the majority of the company’s revenue arrangements are FOB destination. The recognition of revenue is delayed if there are significant post-delivery obligations, such as training, installation or other services. Provisions for discounts, rebates to customers, chargebacks to wholesalers and returns are provided for at the time the related sales are recorded, and are reflected as a reduction to gross sales to arrive at net sales.

The company sometimes enters into arrangements in which it commits to delivering multiple products or services to its customers. In these cases, total arrangement consideration is allocated to the deliverables based on their relative selling prices. Then the allocated consideration is recognized as revenue in accordance with the principles described above. Selling prices are determined by applying a selling price hierarchy and by using vendor specific objective evidence (VSOE), if it exists. Otherwise, selling prices are determined using third party evidence (TPE). If neither VSOE nor TPE is available, the company uses its best estimate of selling prices.

Accounts Receivable and Allowance for Doubtful Accounts

In the normal course of business, the company provides credit to its customers, performs credit evaluations of these customers and maintains reserves for potential credit losses. In determining the amount of the allowance for doubtful accounts, the company considers, among other items, historical credit losses, the past-due status of receivables, payment histories and other customer-specific information. Receivables are written off when the company determines they are uncollectible. The allowance for doubtful accounts was $127 million at December 31, 2016 and $110 million at December 31, 2015.

Product Warranties

The company provides for the estimated costs relating to product warranties at the time the related revenue is recognized. The cost is determined based on actual company experience for the same or similar products, as well as other relevant information. Product warranty liabilities are adjusted based on changes in estimates.

Cash and Equivalents

Cash and equivalents include cash, certificates of deposit and money market funds with an original maturity of three months or less.

Inventories

as of December 31 (in millions)	2016		2015
Raw materials	$	319	$	374
Work in process		122		142
Finished goods		989		1,088
Inventories	$	1,430	$	1,604

Inventories are stated at the lower of cost (first-in, first-out method) or market value. Market value for raw materials is based on replacement costs, and market value for work in process and finished goods is based on net realizable value. The company reviews inventories on hand at least quarterly and records provisions for estimated excess, slow-moving and obsolete inventory, as well as inventory with a carrying value in excess of net realizable value.

Property, Plant and Equipment, Net

as of December 31 (in millions)	2016			2015
Land	$	118		$	116
Buildings and leasehold improvements		1,486			1,389
Machinery and equipment		5,551			5,414
Equipment with customers		1,297			1,238
Construction in progress		710			833
Total property, plant and equipment, at cost		9,162			8,990
Accumulated depreciation		(4,873	)		(4,604	)
Property, plant and equipment (PP&E), net	$	4,289		$	4,386

Depreciation expense is calculated using the straight-line method over the estimated useful lives of the related assets, which range from 20 to 50 years for buildings and improvements and from three to 15 years for machinery and equipment. Leasehold improvements are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. Baxter capitalizes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use as part of machinery and equipment. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the software, and are included in depreciation expense. Straight-line and accelerated methods of depreciation are used for income tax purposes. Depreciation expense was $632 million in 2016, $597 million in 2015 and $613 million in 2014. Depreciation expense in 2016 included accelerated depreciation of $48 million related to business optimization and separation costs.

Acquisitions

Results of operations of acquired companies are included in the company’s results of operations as of the respective acquisition dates. The purchase price of each acquisition is allocated to the net assets acquired based on estimates of their fair values at the date of the acquisition. Any purchase price in excess of these net assets is recorded as goodwill. The allocation of purchase price in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date.

Contingent consideration is recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent payments are recognized in earnings as a component of other income (expense), net. Contingent payments related to acquisitions may consist of development, regulatory and commercial milestone payments, in addition to sales-based payments, and are valued using discounted cash flow techniques. The fair value of development, regulatory and commercial milestone payments reflects management’s expectations of probability of payment, and increases or decreases as the probability of payment or expectation of timing of payments changes. The fair value of sales-based payments is based upon probability-weighted future revenue estimates and increases or decreases as revenue estimates or expectation of timing of payments changes.

Research and Development

Research and development (R&D) costs, including R&D acquired in transactions that are not business combinations, are expensed as incurred. Pre-regulatory approval contingent milestone obligations to counterparties in collaborative arrangements which include acquired R&D are expensed when the milestone is achieved. Contingent milestone payments made to such counterparties on or after regulatory approval are capitalized and amortized over the remaining useful life of the related product. Amounts capitalized for such payments are included in other intangible assets, net of accumulated amortization.

Acquired in-process R&D (IPR&D) is the value assigned to technology or products under development acquired in a business combination which have not received regulatory approval and have no alternative future use.

Acquired IPR&D is capitalized as an indefinite-lived intangible asset. Development costs incurred after the acquisition are expensed as incurred. Upon receipt of regulatory approval of the related technology or product, the indefinite-lived intangible asset is accounted for as a finite-lived intangible asset and amortized on a straight-line basis over the estimated economic life of the related technology or product, subject to annual impairment reviews as discussed below. If the R&D project is abandoned, the indefinite-lived asset is charged to expense.

Collaborative Arrangements

The company enters into collaborative arrangements in the normal course of business. These collaborative arrangements take a number of forms and structures, and are designed to enhance and expedite long-term sales and profitability growth. These arrangements may provide that Baxter obtain commercialization rights to a product under development, and require Baxter to make upfront payments, contingent milestone payments, profit-sharing, and/or royalty payments. Baxter may be responsible for ongoing costs associated with the arrangements, including R&D cost reimbursements to the counterparty. See above regarding the accounting treatment of upfront and contingent payments. Any royalty and profit-sharing payments during the commercialization phase are expensed as cost of sales when they become due and payable.

Business Optimization Charges

The company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. Employee termination costs are primarily recorded when actions are probable and estimable. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Refer to the discussion below regarding the accounting for asset impairment charges.

Goodwill, Intangible Assets, and Other Long-Lived Assets

Goodwill is not amortized, but is subject to an impairment review annually and whenever indicators of impairment exist. Goodwill would be impaired if the carrying amount of a reporting unit exceeded the fair value of that reporting unit, calculated as the present value of estimated cash flows discounted using a risk-free market rate adjusted for a market participant’s view of similar companies and perceived risks in the cash flows. The implied fair value of goodwill is then determined by subtracting the fair value of all identifiable net assets other than goodwill from the fair value of the reporting unit, with an impairment charge recorded for the excess, if any, of carrying amount of goodwill over the implied fair value.

Indefinite-lived intangible assets, such as IPR&D acquired in business combinations and certain trademarks with indefinite lives, are subject to an impairment review annually and whenever indicators of impairment exist. Indefinite-lived intangible assets are impaired if the carrying amount of the asset exceeded the fair value of the asset.

The company reviews the carrying amounts of long-lived assets, other than goodwill and intangible assets not subject to amortization, for potential impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating recoverability, the company groups assets and liabilities at the lowest level such that the identifiable cash flows relating to the group are largely independent of the cash flows of other assets and liabilities. The company then compares the carrying amounts of the assets or asset groups with the related estimated undiscounted future cash flows. In the event impairment exists, an impairment charge is recorded as the amount by which the carrying amount of the asset or asset group exceeds the fair value.

Shipping and Handling Costs

Shipping costs, which are costs incurred to physically move product from Baxter’s premises to the customer’s premises, are classified as marketing and administrative expenses. Handling costs, which are costs incurred to store, move and prepare products for shipment, are classified as cost of sales. Approximately $311 million in 2016, $272 million in 2015 and $319 million in 2014 of shipping costs were classified in marketing and administrative expenses.

Income Taxes

Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The company maintains valuation allowances unless it is more likely than not that the deferred tax asset will be realized. With respect to uncertain tax positions, the company determines whether the position is more likely than not to be sustained upon examination, based on the technical merits of the position. Any tax position that meets the more likely than not recognition threshold is measured and recognized in the consolidated financial statements at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The liability relating to uncertain tax positions is classified as current in the consolidated balance sheets to the extent the company anticipates making a payment within one year. Interest and penalties associated with income taxes are classified in the income tax expense line in the consolidated statements of income.

Foreign Currency Translation

Currency translation adjustments (CTA) related to foreign operations are included in other comprehensive income (OCI). For foreign operations in highly inflationary economies, translation gains and losses are included in other expense (income), net, and were not material in 2016, 2015 and 2014.

Derivatives and Hedging Activities

All derivative instruments are recognized as either assets or liabilities at fair value in the consolidated balance sheets and are classified as short-term or long-term based on the scheduled maturity of the instrument. Based upon the exposure being hedged, the company designates its hedging instruments as cash flow or fair value hedges.

For each derivative instrument that is designated and effective as a cash flow hedge, the gain or loss on the derivative is accumulated in accumulated other comprehensive income (AOCI) and then recognized in earnings consistent with the underlying hedged item. Option premiums or net premiums paid are initially recorded as assets and reclassified to OCI over the life of the option, and then recognized in earnings consistent with the underlying hedged item. Cash flow hedges are classified in net sales, cost of sales, and net interest expense, and primarily related to forecasted third-party sales denominated in foreign currencies, forecasted intercompany sales denominated in foreign currencies and anticipated issuances of debt, respectively.

For each derivative instrument that is designated and effective as a fair value hedge, the gain or loss on the derivative is recognized into earnings, offsetting the loss or gain on the underlying hedged item. Fair value hedges are classified in net interest expense, as they hedge the interest rate risk associated with certain of the company’s fixed-rate debt.

For derivative instruments that are not designated as hedges, the change in fair value is recorded directly to other expense (income), net.

losses relating to terminations of effective cash flow hedges in which the forecasted transactions are still probable of occurring are deferred and recognized consistent with the income or loss recognition of the underlying hedged items. If the company terminates a fair value hedge, an amount equal to the cumulative fair value adjustment to the hedged items at the date of termination is amortized to earnings over the remaining term of the hedged item.

Derivatives, including those that are not designated as a hedge, are principally classified in the operating section of the consolidated statements of cash flows in the same category as the related consolidated balance sheet account.

Refer to Note 9 for further information regarding the company’s derivative and hedging activities.

New Accounting Standards

Recently issued accounting standards not yet adopted

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation. The updated guidance requires all tax effects related to share-based payments be recorded in income tax expense in the consolidated statement of income. Current guidance requires that the tax effects of deductions in excess of share-based compensation costs (windfall tax benefits) be recorded in additional paid-in capital, and tax deficiencies (shortfalls) be recorded in additional paid-in capital to the extent of previously recognized windfall tax benefits, with the remainder recorded in income tax expense. The new guidance also requires all tax-related cash flows resulting from share-based payments to be reported as operating activities in the consolidated statement of cash flows, rather than the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. The guidance is effective for the company beginning January 1, 2017. The impact of the standard is dependent on the timing and value of award exercises and vesting. The company has evaluated the impact of this standard on its consolidated financial statements for 2016, and determined that net income and operating cash flow for the year would have each increased by approximately $39 million if the company had adopted the new standard January 1, 2016.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees are required to recognize a right-of-use asset and a lease liability on the balance sheet for all leases, other than those that meet the definition of a short-term lease. This update will establish a lease asset and lease liability by lessees for those leases classified as operating under current GAAP. Leases will be classified as either operating or finance under the new guidance. Operating leases will result in straight-line expense in the income statement, similar to current operating leases, and finance leases will result in more expense being recognized in the earlier years of the lease term, similar to current capital leases. This ASU is effective for the company beginning January 1, 2019. The company is currently evaluating the impact of this standard on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which amends the existing accounting standards for revenue recognition. ASU No. 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers. ASU No. 2014-09 will be effective for the company beginning on January 1, 2018. The standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The company has completed an assessment of the new standard and is in the process of finalizing its detailed implementation plan and evaluating the disclosure requirements under the new standard. Based on the work performed to date, the company does not expect the adoption of the new standard to have a material impact on the consolidated financial statements. The company has not finalized its transition method for adoption.

Recently adopted accounting pronouncements

As of January 1, 2016, the company adopted ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which amended ASC 835-30, Interest – Imputation of Interest. This guidance requires that debt issuance costs related to a recognized debt liability be presented as a direct deduction from the carrying amount of the related debt liability. As a result of the adoption, the company reclassified debt issuance costs of $13 million from other assets to long-term debt in the company’s consolidated balance sheet as of December 31, 2015. The adoption of this guidance did not impact the company’s consolidated statements of income, comprehensive income, changes in equity or cash flows.

As of January 1, 2016, the company adopted ASU No. 2015-05, Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40), Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. This update provides guidance on determining whether a cloud-based computer arrangement includes a software license. If it is determined that the arrangement includes a software license, then the customer is to account for that element in a manner that is consistent with the acquisition of other software licenses. If it is determined that the arrangement does not include a software license, then it is to be accounted for as a service

contract. The company elected to adopt the amendments prospectively to all arrangements entered into or materially modified after the effective date. The adoption of ASU No. 2015-05 did not have a material impact on the company’s consolidated financial statements.

As of July 1, 2016, the company adopted ASU No. 2016-15, Statement of Cash Flows (Topic 230). The guidance requires that the cash payments for debt prepayment or debt extinguishment costs be classified as cash outflows for financing activities. As a result of the adoption, in the third quarter of 2016 the company reclassified certain debt repayments and debt extinguishment costs from operating to financing activities which resulted in a decrease in financing cash flows of $16 million and $124 million for 2016 and 2015, respectively. The adoption of this guidance did not impact the company’s consolidated statements of income, consolidated balance sheets, comprehensive income or changes in equity.

NOTE 2

SEPARATION OF BAXALTA INCORPORATED

After giving effect to the Distribution, the company retained 19.5% of the outstanding common stock, or 131,902,719 shares of Baxalta (Retained Shares). Effective January 27, 2016, Baxter completed a debt-for-equity exchange through the transfer of 37,573,040 Retained Shares in exchange for the extinguishment of the $1.45 billion aggregate principal amount of indebtedness outstanding under the company’s prior U.S. dollar denominated revolving credit facility, which was terminated in connection with the closing of this exchange. On March 16, 2016, the company completed a debt-for-equity exchange, in which Baxter exchanged 63,823,582 Retained Shares for the extinguishment of $2.2 billion in aggregate principal amount of Baxter indebtedness. On May 6, 2016, the company contributed 17,145,570 Retained Shares to Baxter’s U.S. pension fund. On May 26, 2016, the company completed an equity-for-equity exchange by exchanging 13,360,527 Retained Shares for 11,526,638 shares of Baxter. The company held no shares of Baxalta as of December 31, 2016. Refer to Note 10 for additional details regarding these transactions.

The following table is a summary of the operating results of Baxalta, which have been reflected as discontinued operations for the years ended December 31, 2016, 2015 and 2014.

Years ended December 31 (in millions)	2016			2015			2014
Major classes of line items constituting income from discontinued operations before income taxes
Net sales	$	148		$	2,895		$	6,523
Cost of sales		(139	)		(1,214	)		(2,475	)
Marketing and administrative expenses		(20	)		(547	)		(769	)
Research and development expenses		—			(389	)		(822	)
Other income and expense items that are not major		1			7			105
Total (loss) income from discontinued operations before income taxes		(10	)		752			2,562
Gain on disposal of discontinued operations		19			—			—
Income tax expense		10			177			522
Total (loss) income from discontinued operations	$	(1	)	$	575		$	2,040

For a portion of Baxalta’s operations, the legal transfer of Baxalta’s assets and liabilities did not occur with the separation of Baxalta on July 1, 2015 due to the time required to transfer marketing authorizations and other regulatory requirements in certain countries. Under the terms of the International Commercial Operations Agreement (ICOA), Baxalta is subject to the risks and entitled to the benefits generated by these operations and assets until legal transfer; therefore, the net economic benefit and any cash collected by these entities are transferred to Baxalta. Separation of the remaining three countries is expected to occur by 2018.

The assets and liabilities of Baxalta have been classified as held for disposition as of December 31, 2016 and 2015. These amounts consist of the following carrying amounts in each major class.

As of December 31 (in millions)	2016		2015
Carrying amounts of major classes of assets included as part of discontinued operations
Accounts and other current receivables, net	$	48	$	228
Inventories		—		8
Property, plant, and equipment, net		1		2
Other		1		7
Total assets of the disposal group	$	50	$	245
Carrying amounts of major classes of liabilities included as part of discontinued operations
Accounts payable and accrued liabilities	$	3	$	46
Total liabilities of the disposal group	$	3	$	46

As of December 31, 2016 and 2015, Baxter recorded a liability of $46 million and $190 million, respectively, for its obligation to transfer these net assets to Baxalta. In 2016, the company transferred $161 million of net assets to Baxalta resulting in a gain of $19 million, which is recorded within income from discontinued items, net of tax.

Baxter and Baxalta entered into several additional agreements in connection with the July 1, 2015 separation, including a transition services agreement (TSA), separation and distribution agreement, manufacturing and supply agreements (MSA), tax matters agreement, an employee matters agreement, a long-term services agreement, and a shareholder’s and registration rights agreement.

Pursuant to the TSA, Baxter and Baxalta and their respective subsidiaries are providing to each other, on an interim, transitional basis, various services. Services being provided by Baxter include, among others, finance, information technology, human resources, quality supply chain and certain other administrative services. The services generally commenced on the Distribution date and are expected to terminate within 24 months (or 36 months in the case of certain information technology services) of the Distribution date. Billings by Baxter under the TSA are recorded as a reduction of the costs to provide the respective service in the applicable expense category, primarily in marketing and administrative expenses, in the consolidated statements of income. In 2016 and 2015, the company recognized approximately $101 million and $75 million, respectively, as a reduction to marketing and administrative expenses related to the TSA.

Pursuant to the MSA, Baxalta or Baxter, as the case may be, manufactures, labels, and packages products for the other party. The terms of the agreements range in initial duration from five to 10 years. In 2016 and 2015, Baxter recognized approximately $39 million and $37 million, respectively, in sales to Baxalta. In addition, in 2016 and 2015, Baxter recognized approximately $189 million and $100 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. The cash flows associated with these agreements are included in cash flows from operations — continuing operations.

In December 2015, Baxter sold to Baxalta certain assets for approximately $28 million with no resulting impact to net income.

Cash inflows of $30 million were reported in cash flows from operations – discontinued operations in 2016. These relate to non-assignable tenders whereby Baxter remains the seller of Baxalta products, transactions related to importation services Baxter provides in certain countries, in addition to trade payables settled by Baxter on Baxalta’s behalf after the local separation.

NOTE 3

SUPPLEMENTAL FINANCIAL INFORMATION

Prepaid Expenses and Other

as of December 31 (in millions)	2016		2015
Prepaid value added taxes	$	114	$	118
Prepaid income taxes		147		302
Other		341		435
Prepaid expenses and other	$	602	$	855

Other Long-Term Assets

as of December 31 (in millions)	2016		2015
Deferred income taxes	$	629	$	354
Other long-term receivables		181		176
All other		167		214
Other long-term assets	$	977	$	744

Accounts Payable and Accrued Liabilities

as of December 31 (in millions)	2016		2015
Accounts payable, principally trade	$	791	$	716
Common stock dividends payable		70		137
Employee compensation and withholdings		542		481
Property, payroll and certain other taxes		143		166
Infusion pump reserves		—		52
Business optimization reserves		153		98
Accrued rebates		206		192
Separation-related reserves		46		190
All other		661		634
Accounts payable and accrued liabilities	$	2,612	$	2,666

Other Long-Term Liabilities

as of December 31 (in millions)	2016		2015
Pension and other employee benefits	$	1,492	$	2,041
Deferred tax liabilities		93		195
Litigation reserves		19		24
Business optimization reserves		11		18
Contingent payment liabilities		15		20
All other		113		127
Other long-term liabilities	$	1,743	$	2,425

Net Interest Expense

years ended December 31 (in millions)	2016		2015			2014
Interest costs	$	107	$	197		$	237
Interest costs capitalized		(18)		(51	)		(70	)
Interest expense		89		146			167
Interest income		(23)		(20	)		(22	)
Net interest expense	$	66	$	126		$	145

Other (Income) Expense, net

years ended December 31 (in millions)	2016		2015			2014
Foreign exchange	$	(28)	$	(113	)	$	(8	)
Net loss on debt extinguishment		153		130			—
Net realized gains on Retained Shares transaction		(4,387)		—			—
Gain on litigation settlement		—		(52	)		—
Gain on sale of investments and other assets		(3)		(38	)		(20	)
All other		(31)		(32	)		49
Other (income) expense, net	$	(4,296)	$	(105	)	$	21

NOTE 4

EARNINGS PER SHARE

The numerator for both basic and diluted earnings per share (EPS) is either net income, income from continuing operations, or income from discontinued operations. The denominator for basic EPS is the weighted-average number of common shares outstanding during the period. The dilutive effect of outstanding stock options, restricted stock units (RSUs) and performance share units (PSUs) is reflected in the denominator for diluted EPS using the treasury stock method.

The following table is a reconciliation of basic shares to diluted shares.

years ended December 31 (in millions)
Basic shares	546	545	542
Effect of dilutive securities	5	4	5
Diluted shares	551	549	547

The effect of dilutive securities included unexercised stock options, unvested RSUs and contingently issuable shares related to granted PSUs. All outstanding equity awards were dilutive as of December 31, 2016, while the computation of diluted EPS excluded 18 million and 9 million equity awards in 2015 and 2014, respectively, because their inclusion would have had an anti-dilutive effect on diluted EPS. Refer to Note 12 for additional information regarding items impacting basic shares.

NOTE 5

ACQUISITIONS AND OTHER ARRANGEMENTS

Claris Injectables Limited

In December 2016, Baxter entered into a definitive agreement to acquire Claris Injectables Limited (Claris), a wholly owned subsidiary of Claris Lifesciences Limited, for total consideration of approximately $625 million. Upon closing, Claris will add capabilities in production of essential generic injectable medicines, such as anesthesia and analgesics, renal, anti-infectives and critical care in a variety of presentations including bags, vials and ampoules. The Boards of Directors of both companies have approved the proposed acquisition, which is expected to close in the second half of 2017. Closing of the deal is subject to satisfaction of regulatory approvals and other closing conditions, including achievement of a specified revenue target.

JW Holdings Corporation

In July 2013, Baxter entered into a collaboration agreement with JW Holdings Corporation (JW Holdings) for parenteral nutritional products containing a novel formulation of omega 3 lipids. Baxter has exclusive rights to co-develop and distribute the products globally, with the exception of Korea. In 2013, Baxter recognized an R&D charge of $25 million related to an upfront payment. As of December 31, 2016, Baxter had the potential to make future payments of up to $8 million relating to the achievement of regulatory milestones, in addition to future royalty payments.

Celerity Pharmaceuticals, LLC

In September 2013, Baxter entered into an agreement with Celerity Pharmaceutical, LLC (Celerity), a company of Water Street Healthcare Partners III, LLP, to develop certain acute care generic injectable premix and oncolytic molecules through regulatory approval. Baxter transferred its rights in these molecules to Celerity and Celerity assumed ownership and responsibility for development of the molecules. Baxter is obligated to purchase the individual product rights from Celerity if the products obtain regulatory approval. In 2015, Baxter paid $14 million to acquire the rights to cefazolin injection in GALAXY Container (2 g/100 mL). In 2016, Baxter paid approximately $23 million to acquire the rights to vancomycin injection 0.9% Sodium Chloride (Normal Saline) in 500 mg, 750 mg and 1 gram presentations. For both intangible assets, Baxter capitalized the purchase price as an intangible asset and is amortizing the asset over the estimated economic life of 12 years. As of December 31, 2016, Baxter’s estimated future payments total up to $273 million upon Celerity’s achievement of specified regulatory approvals.

NOTE 6

GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill

The following table is a summary of the activity in goodwill by segment.

(in millions)	Renal			Hospital Products			Total
December 31, 2014	$	445		$	2,482		$	2,927
Additions		—			—			—
Currency translation and other adjustments		(37	)		(203	)		(240	)
December 31, 2015	$	408		$	2,279		$	2,687
Additions		3			—			3
Currency translation and other adjustments		(14	)		(81	)		(95	)
December 31, 2016	$	397		$	2,198		$	2,595

As a result of the separation of Baxalta in July 2015, the goodwill associated with Baxter’s former BioScience segment has been eliminated. The remaining goodwill was allocated from the former Medical Products segment to the Renal and Hospital Products segments using the relative fair value approach.

As of December 31, 2016, there were no reductions in goodwill relating to impairment losses.

Other Intangible Assets, Net

The following table is a summary of the company’s other intangible assets.

(in millions)	Developed technology, including patents			Other amortized intangible assets			Indefinite-lived intangible assets		Total
December 31, 2016
Gross other intangible assets	$	1,690		$	384		$	57	$	2,131
Accumulated amortization		(855	)		(165	)		—		(1,020	)
Other intangible assets, net	$	835		$	219		$	57	$	1,111
December 31, 2015
Gross other intangible assets	$	1,742		$	393		$	86	$	2,221
Accumulated amortization		(729	)		(143	)		—		(872	)
Other intangible assets, net	$	1,013		$	250		$	86	$	1,349

Intangible asset amortization expense was $163 million in 2016, $158 million in 2015 and $169 million in 2014. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2016 is $138 million in 2017, $125 million in 2018, $121 million in 2019, $118 million in 2020 and $114 million in 2021.

In 2016, the company recorded an impairment charge of $27 million related to an indefinite-lived intangible asset (acquired IPR&D) in the company’s Renal segment relating to its in-center hemodialysis program. The asset was written down to estimated fair value and recorded in research and development expenses. Additionally, the company recorded an impairment charge of $51 million, of which $41 million related to a developed technology asset, relating to the company’s Hospital Products segment synthetic bone repair products business which was acquired from ApaTech Limited in 2010. The assets of the business were written down to estimated fair value and recorded in cost of sales.

In 2015, the company recorded impairments of approximately $10 million related to acquired IPR&D and $13 million related to developed technology.

NOTE 7

INFUSION PUMP AND BUSINESS OPTIMIZATION CHARGES

Infusion Pump Charges

The company had undertaken a field corrective action with respect to the SIGMA Spectrum Infusion Pump, which is predominantly sold in the United States. The United States Food and Drug Administration (FDA) categorized the action as a Class 1 recall during the second quarter of 2014. Remediation primarily included software-related corrections and a replacement pump in a limited number of cases. In 2014, the company recorded a charge of $93 million related primarily to cash costs associated with remediation efforts and utilized $4 million in 2014. During 2015, the company refined its expectations relating to the costs associated with the remediation effort and recorded partial reversals of the cash and non-cash reserves totaling $26 million and $10 million, respectively. Additionally the company utilized $13 million of the cash reserves during 2015. In 2016, the company recorded utilization of cash and non-cash reserves of $22 million and $3 million, respectively, as well as partial reversals of cash and non-cash reserves of $11 million and $1 million, respectively. As of December 31, 2016, the remediation efforts are substantially complete and the remaining costs and reserves are considered immaterial to the company.

From 2005 through 2014, the company recorded total charges and adjustments of $863 million related to the COLLEAGUE and SYNDEO infusion pumps, including $700 million of cash costs and $163 million principally related to asset impairments.

The following table summarizes cash activity and reserve adjustments related to the company’s COLLEAGUE and SYNDEO infusion pump reserves through December 31, 2016.

(in millions)
Charges and adjustments in 2005 through 2014	$	700
Utilization in 2005 through 2014		(678	)
Reserves at December 31, 2014		22
Reserve adjustments		(7	)
Utilization		(8	)
Reserves at December 31, 2015		7
Reserve adjustments		(4	)
Utilization		(3	)
Reserves at December 31, 2016	$	—

As of December 31, 2016, the company has completed its field corrective actions related to the COLLEAGUE and SYNDEO infusion pumps.

Business Optimization Charges

Beginning in the second half of 2015, the company has initiated actions to transform the company’s cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing the manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through December 31, 2016 the company incurred cumulative pretax costs of $407 million related to these actions. The costs consisted primarily of employee termination, implementation costs, and accelerated depreciation. The company expects to incur additional pretax costs of approximately $390 million and capital expenditures of $90 million through the completion of these initiatives. These costs will primarily include employee termination costs, implementation costs, and accelerated depreciation. Of this amount, the company expects that approximately 10 percent of the charges will be non-cash.

In addition to the programs above, the company recorded additional net business optimization charges of $125 million in 2016. These charges primarily include employee termination costs, contract termination costs, asset impairments, and Gambro integration costs. Approximately 40% of these costs were non-cash. The company does not anticipate incurring any additional costs related to these programs in the future and expects them to be substantially completed by the end of 2017.

The company recorded the following charges related to business optimization programs in 2016, 2015, and 2014:

years ended December 31 (in millions)	2016		2015		2014
Restructuring charges, net	$	285	$	130	$	(6	)
Costs to implement business optimization programs		65		—		—
Gambro integration costs		26		73		144
Accelerated depreciation		33		—		—
Total business optimization charges	$	409	$	203	$	138

Included in the restructuring charges for 2016 were net employee termination costs of $180 million which primarily consisted of a global workforce reduction program and $27 million related to the impairment of acquired IPR&D as described in Note 6. Restructuring charges for 2016 also included $54 million for costs associated with the discontinuation of the VIVIA home hemodialysis development program. These costs consist of contract termination costs of $21 million, asset impairments of $31 million and other exit costs of $2 million.

Included in the restructuring charges for 2015 were net employee termination costs of $83 million which primarily related to the global workforce reduction program mentioned above. Additionally, asset impairments of $13 million and $29 million were recorded related to a developed technology intangible assets and a manufacturing facility rationalization program, respectively.

Restructuring charges recorded in 2014 primarily related to employee and contract termination costs associated with legacy, non-transformational restructuring initiatives.

The company recorded the following components of restructuring costs in 2016, 2015 and 2014:

	2016
(in millions)	COGS			SGA			R&D			Total
Employee termination costs	$	72		$	109		$	13		$	194
Contract termination costs		9			5			13			27
Asset impairments		38			—			40			78
Reserve adjustments
Employee termination costs		(1	)		(11	)		(2	)		(14	)
Total restructuring charges	$	118		$	103		$	64		$	285

	2015
(in millions)	COGS			SGA			R&D			Total
Employee termination costs	$	14		$	86		$	15		$	115
Contract termination costs	$	3		$	2		$	—		$	5
Asset impairment		40			—			2			42
Reserve adjustments
Employee termination costs		(19	)		(10	)		(3	)		(32	)
Total restructuring charges	$	38		$	78		$	14		$	130

	2014
(in millions)	COGS			SGA			R&D			Total
Employee termination costs	$	10		$	24		$	—		$	34
Contract termination costs		2			6			2			10
Asset impairment		2			2			—			4
Reserve adjustments
Employee termination costs		(19	)		(31	)		1			(49	)
Contract termination costs		(3	)		—			—			(3	)
Asset impairment		(2	)		—			—			(2	)
Total restructuring charges	$	(10	)	$	1		$	3		$	(6	)

Costs to implement business optimization programs in 2016 were $65 million. These costs consisted primarily of external consulting and employee salary and related costs. The costs were included within marketing and administrative and R&D expense.

Costs related to the integration of Gambro were included within marketing and administrative expense for all referenced periods.

In 2016, the company recognized accelerated depreciation, primarily associated with facilities to be closed of $33 million. The costs were recorded in cost of sales.

The following table summarizes cash activity in the reserves related to the company’s business optimization initiatives.

(in millions)
Reserve at December 31, 2013	$	244
2014 charges		44
Reserve adjustments		(54	)
Utilization in 2014		(88	)
CTA		(19	)
Reserve at December 31, 2014		127
2015 charges		120
Reserve adjustments		(32	)
Utilization in 2015		(89	)
CTA		(10	)
Reserve at December 31, 2015		116
2016 charges		221
Reserve adjustments		(14	)
Utilization in 2016		(164	)
CTA		5
Reserve at December 31, 2016	$	164

Reserve adjustments primarily relate to employee termination cost reserves established in prior periods.

The company’s restructuring reserves of $164 million as of December 31, 2016 consisted of $146 million of employee termination costs and the remaining reserves related to contract termination costs. The reserves are expected to be substantially utilized by the end of 2018.

NOTE 8

DEBT, CREDIT FACILITIES AND LEASE COMMITMENTS

Debt Outstanding

At December 31, 2016 and 2015, the company had the following debt outstanding:

as of December 31 (in millions)	2016		2015
Line of credit	$	—	$	1,450
Commercial paper		—		300
Other short-term debt		—		25
Short-term debt	$	—	$	1,775

as of December 31 (in millions)			20162			20152
5.9% notes due 2016	5.8	%		—			301
0.95% notes due 2016	1.2	%		—			500
1.85% notes due 2017	2.1	%		—			499
5.375% notes due 2018	5.7	%		—			501
1.85% notes due 2018	2.1	%		—			747
4.5% notes due 2019	4.5	%		—			530
4.25% notes due 2020	4.2	%		—			299
Variable-rate loan due 2020	1.0	%		294			281
1.7% notes due 2021	1.6	%		397			—
2.40% notes due 2022	2.5	%		208			211
3.2% notes due 2023	3.1	%		—			146
2.6% notes due 2026	2.2	%		744			—
7.65% debentures due 2027	7.7	%		5			5
6.625% debentures due 2028	6.7	%		99			100
6.25% notes due 2037	5.8	%		265			265
3.65% notes due 2042	3.7	%		6			6
4.5% notes due 2043	4.5	%		255			255
3.5% notes due 2046	3.0	%		439			—
Other	—			70			86
Total debt and capital lease obligations				2,782			4,732
Current portion				(3	)		(810	)
Long-term portion			$	2,779		$	3,922

1	Excludes the effect of any related interest rate swaps.

2	Book values include any discounts, premiums and adjustments related to hedging instruments.

Significant Debt Issuances

In August 2016, Baxter issued senior notes with a total aggregate principal amount of $1.6 billion, comprised of $400 million at a fixed coupon rate of 1.70% due in August 2021, $750 million at a fixed coupon rate of 2.60% due in August 2026 and $450 million at a fixed coupon rate of 3.50% due in August 2046.

In June 2015, the company’s then wholly-owned subsidiary Baxalta issued senior notes with a total aggregate principal amount of $5.0 billion. Approximately $4.0 billion of the related net proceeds were distributed to Baxter in connection with the separation. After the separation, Baxter has no obligations as it relates to the Baxalta senior notes or any other Baxalta indebtedness. Refer to the debt tender offer section below in connection with this debt issuance.

Debt Redemption

In September 2016, Baxter redeemed an aggregate of approximately $1 billion in principal amount of its 1.850% Senior Notes due 2017, 1.850% Senior Notes due 2018, 5.375% Senior Notes due 2018, 4.500% Senior Notes due 2019, 4.250% Senior Notes due 2020 and 3.200% Senior Notes due 2023. Baxter paid approximately $1 billion, including accrued and unpaid interest and tender premium, to redeem such notes. As a result of the debt redemptions, the company recognized a loss on extinguishment of debt in the third quarter of 2016 of approximately $52 million, which is included in other (income) expense, net.

Debt-for-Equity Exchanges

As of December 31, 2015, the company had drawn $1.45 billion under its $1.8 billion U.S. dollar-denominated revolving credit facility at a weighted average interest rate of 1.41%. On January 27, 2016, Baxter exchanged Retained Shares for the extinguishment of $1.45 billion aggregate principal amount outstanding under its $1.8 billion U.S. dollar-denominated revolving credit facility. This exchange extinguished the indebtedness under the facility, which was terminated in connection with such debt-for-equity exchange. There were no material prepayment penalties or breakage costs associated with the termination of the facility. Baxter recognized a net realized gain of $1.25 billion related to the Retained Shares exchanged, which is included in other (income) expense, net in 2016.

On March 16, 2016, the company exchanged Retained Shares for the extinguishment of approximately $2.2 billion in principal amount of its 0.950% Notes due May 2016, 5.900% Notes due August 2016, 1.850% Notes due January 2017, 5.375% Notes due May 2018, 1.850% Notes due June 2018, 4.500% Notes due August 2019 and 4.250% Notes due February 2020 purchased by certain third party purchasers in the previously announced debt tender offers. As a result, the company recognized a net loss on extinguishment of debt totaling $101 million and a net realized gain of $2.0 billion on the Retained Shares exchanged, which are included in other (income) expense, net in 2016.

Debt Maturities

In the second quarter of 2016, the company repaid the $190 million outstanding balance of its 0.95% senior unsecured notes that matured in June 2016. In the third quarter of 2016, the company repaid the $130 million outstanding balance of its 5.9% senior unsecured notes that matured in September 2016.

Debt Tender Offer

On July 6, 2015 and July 21, 2015 the company purchased an aggregate of approximately $2.7 billion in principal amount of its 5.900% Notes due September 2016, 6.625% Debentures due February 2028, 6.250% Notes due December 2037, 3.650% Notes due August 2042, 4.500% Notes due June 2043, 3.200% Notes due June 2023, and 2.400% Notes due August 2022 pursuant to a debt tender offer. Baxter paid approximately $2.9 billion, including accrued and unpaid interest and tender premium, to purchase such notes. As a result of the debt tender offers the company recognized a loss on extinguishment of debt in the third quarter of 2015 of $130 million, which is included in other (income) expense, net within the Consolidated Statements of Income.

Credit Facilities

Effective July 1, 2015, the company terminated its $1.5 billion U.S. dollar-denominated revolving credit facility and €300 million Euro denominated revolving credit facility and entered into credit agreements providing for a senior U.S. dollar-denominated revolving credit facility in an aggregate principal amount of up to $1.5 billion maturing in 2020, as well as a Euro-denominated senior revolving credit facility in an aggregate principal amount of up to €200 million maturing in 2020. As of December 31, 2016 there were zero borrowings outstanding under the company’s revolving credit facilities. The facilities enable the company to borrow funds on an unsecured basis at variable interest rates, and contain various covenants, including a maximum net leverage ratio and maximum interest coverage ratio.

The company also maintains other credit arrangements, which totaled $271 million at December 31, 2016 and $307 million at December 31, 2015. There were no borrowings outstanding under these arrangements at December 31, 2016 and $25 million of borrowings outstanding at December 31, 2015.

At December 31, 2016, the company was in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting any of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment.

Commercial Paper

During 2016, the company issued and redeemed commercial paper, and no commercial paper was outstanding at December 31, 2016. There was a balance of $300 million outstanding at December 31, 2015 with a weighted-average interest rate of 0.6%.

Leases

The company leases certain facilities and equipment under capital and operating leases expiring at various dates. The leases generally provide for the company to pay taxes, maintenance, insurance and certain other operating costs of the leased property. Most of the operating leases contain renewal options. For the years ending December 31, 2016, 2015, and 2014 operating lease rent expense was $174 million, $184 million and $203 million, respectively.

Future Minimum Lease Payments and Debt Maturities

as of and for the years ended December 31 (in millions)	Operating leases		Debt maturities and capital leases
2017	$	129	$	3
2018		108		3
2019		85		3
2020		67		297
2021		58		403
Thereafter		216		2,085
Total obligations and commitments		663		2,794
Discounts, premiums, and adjustments relating to hedging instruments		—		(12	)
Total debt and lease obligations	$	663	$	2,782

NOTE 9

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY

Foreign Currency and Interest Rate Risk Management

The company operates on a global basis and is exposed to the risk that its earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. The company’s hedging policy attempts to manage these risks to an acceptable level based on the company’s judgment of the appropriate trade-off between risk, opportunity and costs.

The company is primarily exposed to foreign exchange risk with respect to recognized assets and liabilities, forecasted transactions and net assets denominated in the Euro, British Pound, Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar, Japanese Yen, Colombian Peso, Brazilian Real, Swedish Krona, Mexican Peso and New Zealand Dollar. The company manages its foreign currency exposures on a consolidated basis, which allows the company to net exposures and take advantage of any natural offsets. In addition, the company uses derivative and nonderivative instruments to further reduce the net exposure to foreign exchange. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and equity volatility resulting from foreign exchange. Financial market and currency volatility may limit the company’s ability to cost-effectively hedge these exposures.

The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company’s policy is to manage interest costs using a mix of fixed- and floating-rate debt that the company believes is appropriate. To manage this mix in a cost-efficient manner, the company periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount.

The company does not hold any instruments for trading purposes and none of the company’s outstanding derivative instruments contain credit-risk-related contingent features.

Cash Flow Hedges

The company may use options, including collars and purchased options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions and recognized assets and liabilities. The company periodically uses

forward-starting interest rate swaps and treasury rate locks to hedge the risk to earnings associated with movements in interest rates relating to anticipated issuances of debt. Certain other firm commitments and forecasted transactions are also periodically hedged. Cash flow hedges primarily related to forecasted intercompany sales denominated in foreign currencies, and anticipated issuances of debt.

The notional amounts of foreign exchange contracts were $561 million and $378 million as of December 31, 2016 and 2015, respectively. The company did not have any interest rate contracts designated as cash flow hedges outstanding at December 31, 2016 and 2015. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions at December 31, 2016 is 12 months.

Fair Value Hedges

The company uses interest rate swaps to convert a portion of its fixed-rate debt into variable-rate debt. These instruments hedge the company’s earnings from changes in the fair value of debt due to fluctuations in the designated benchmark interest rate.

The total notional amount of interest rate contracts designated as fair value hedges was $200 million and $1.3 billion as of December 31, 2016 and 2015, respectively.

Dedesignations

If it is determined that a derivative or nonderivative hedging instrument is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If the company removes the cash flow hedge designation because the hedged forecasted transactions are no longer probable of occurring, any gains or losses are immediately reclassified from AOCI to earnings. Gains or losses relating to terminations of effective cash flow hedges in which the forecasted transactions are still probable of occurring are deferred and recognized consistent with the loss or income recognition of the underlying hedged items.

There were no hedge dedesignations in 2016, 2015 or 2014 resulting from changes in the company’s assessment of the probability that the hedged forecasted transactions would occur.

If the company terminates a fair value hedge, an amount equal to the cumulative fair value adjustment to the hedged items at the date of termination is amortized to earnings over the remaining term of the hedged item. In 2016, the company terminated a total notional value of $765 million of interest rate contracts in connection with the March 2016 debt tender offers, resulting in a $34 million reduction to the debt extinguishment loss. In 2015, the company terminated $1.65 billion of interest rate contracts in connection with the July debt tender offers, which resulted in a $33 million reduction to the debt extinguishment loss. There were no fair value hedges terminated during 2014.

Undesignated Derivative Instruments

The company uses forward contracts to hedge earnings from the effects of foreign exchange relating to certain of the company’s intercompany and third-party receivables and payables denominated in a foreign currency. These derivative instruments are generally not formally designated as hedges and the terms of these instruments generally do not exceed one month.

The total notional amount of undesignated derivative instruments was $822 million as of December 31, 2016 and $580 million as of December 31, 2015.

Gains and Losses on Derivative Instruments

The following table summarizes the gains and losses on the company’s derivative instruments for the years ended December 31, 2016, 2015, and 2014.

	Gain (loss) recognized in OCI							Location of gain (loss) in	Gain (loss) reclassified from AOCI into income
(in millions)	2016		2015			2014		income statement	2016			2015		2014
Cash flow hedges
Interest rate contracts	$	—	$	—		$	—	Other (income) expense, net	$	9		$	—	$	(1	)
Foreign exchange contracts	—			(1	)		1	Net sales		—			—		1
Foreign exchange contracts		1		4			51	Cost of sales		(3	)		47		13
Total	$	1	$	3		$	52		$	6		$	47	$	13

	Location of gain (loss) in income statement	Gain (loss) recognized in income
(in millions)		2016		2015			2014
Fair value hedges
Interest rate contracts	Net interest expense	$	9	$	(43	)	$	68
Undesignated derivative instruments
Foreign exchange contracts	Other (income) expense, net	$	4	$	(13	)	$	49

For the company’s fair value hedges, equal and offsetting losses of $9 million, gains of $43 million and losses of $68 million were recognized in net interest expense in 2016, 2015 and 2014, respectively, as adjustments to the underlying hedged items, fixed-rate debt. Ineffectiveness related to the company’s cash flow and fair value hedges for the year ended December 31, 2016 was not material.

The following table summarizes net-of-tax activity in AOCI, a component of shareholders’ equity, related to the company’s cash flow hedges.

as of and for the years ended December 31 (in millions)	2016			2015			2014
Accumulated other comprehensive income (loss) balance at beginning of year	$	7		$	34		$	10
Gain in fair value of derivatives during the year		1			4			32
Amount reclassified to earnings during the year		(5	)		(31	)		(8	)
Accumulated other comprehensive income balance at end of year	$	3		$	7		$	34

As of December 31, 2016, $3 million of deferred, net after-tax gains on derivative instruments included in AOCI are expected to be recognized in earnings during the next 12 months, coinciding with when the hedged items are expected to impact earnings.

Fair Values of Derivative Instruments

The following table summarizes the classification and fair value amounts of derivative instruments reported in the consolidated balance sheet as of December 31, 2016.

	Derivatives in asset positions			Derivatives in liability positions
(in millions)	Balance sheet location	Fair value		Balance sheet location	Fair value
Derivative instruments designated as hedges
Interest rate contracts	Other long-term assets	$	7	Other long-term liabilities	$	—
Foreign exchange contracts	Prepaid expenses and other		22	Accounts payable and accrued liabilities		1
Total derivative instruments designated as hedges		$	29		$	1
Undesignated derivative instruments
Foreign exchange contracts	Prepaid expenses and other	$	1	Accounts payable and accrued liabilities	$	2
Total derivative instruments		$	30		$	3

The following table summarizes the classification and fair value amounts of derivative instruments reported in the consolidated balance sheet as of December 31, 2015.

	Derivatives in asset positions			Derivatives in liability positions
(in millions)	Balance sheet location	Fair value		Balance sheet location	Fair value
Derivative instruments designated as hedges
Interest rate contracts	Other long-term assets	$	46	Other long-term liabilities	$	—
Foreign exchange contracts	Prepaid expenses and other		9	Accounts payable and accrued liabilities		1
Total derivative instruments designated as hedges		$	55		$	1
Undesignated derivative instruments
Foreign exchange contracts	Prepaid expenses and other	$	1	Accounts payable and accrued liabilities	$	1
Total derivative instruments		$	56		$	2

While the company’s derivatives are all subject to master netting arrangements, the company presents its assets and liabilities related to derivative instruments on a gross basis within the consolidated balance sheets. Additionally, the company is not required to post collateral for any of its outstanding derivatives. The following table provides information on the company’s derivative positions as if they were presented on a net basis, allowing for the right of offset by counterparty.

	December 31, 2016						December 31, 2015
(in millions)	Asset			Liability			Asset			Liability
Gross amounts recognized in the consolidated balance sheet	$	30		$	3		$	56		$	2
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet		(3	)		(3	)		(2	)		(2	)
Total	$	27		$	—		$	54		$	—

NOTE 10

FINANCIAL INSTRUMENTS AND RELATED FAIR VALUE MEASUREMENTS

Receivable Securitizations

For trade receivables originated in Japan, the company has entered into agreements with financial institutions in which the entire interest in and ownership of the receivable is sold. The company continues to service the receivables in its Japanese securitization arrangement. Servicing assets or liabilities are not recognized because the company receives adequate compensation to service the sold receivables. The Japanese securitization arrangement includes limited recourse provisions, which are not material.

The following is a summary of the activity relating to the securitization arrangement.

as of and for the years ended December 31 (in millions)	2016			2015			2014
Sold receivables at beginning of year	$	81		$	104		$	114
Proceeds from sales of receivables		348			361			464
Cash collections (remitted to the owners of the receivables)		(367	)		(384	)		(459	)
Effect of currency exchange rate changes		6			—			(15	)
Sold receivables at end of year	$	68		$	81		$	104

The net losses relating to the sales of receivables were immaterial for each year.

Concentrations of Credit Risk

The company invests excess cash in certificates of deposit or money market funds and diversifies the concentration of cash among different financial institutions. With respect to financial instruments, where appropriate, the company has diversified its selection of counterparties, and has arranged collateralization and master-netting agreements to minimize the risk of loss.

The company continues to do business with foreign governments in certain countries, including Greece, Spain, Portugal and Italy, which have experienced deterioration in credit and economic conditions. As of December 31, 2016 and 2015, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $137 million and $211 million, respectively.

Global economic conditions and liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses. Global economic conditions, governmental actions and customer-specific factors may require the company to re-evaluate the collectability of its receivables and the company could potentially incur additional credit losses. These conditions may also impact the stability of the Euro.

Fair Value Measurements

The fair value hierarchy under the accounting standard for fair value measurements consists of the following three levels:

	•	Level 1 — Quoted prices in active markets that the company has the ability to access for identical assets or liabilities;

	•	Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market; and

	•	Level 3 — Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company’s management about the assumptions market participants would use in pricing the asset or liability.

The following table summarizes the bases used to measure financial assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheets.

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2016		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Foreign currency hedges	$	23	$	—	$	23	$	—
Interest rate hedges		7		—		7		—
Available-for-sale securities		9		9		—		—
Total assets	$	39	$	9	$	30	$	—
Liabilities
Foreign currency hedges	$	3	$	—	$	3	$	—
Contingent payments related to acquisitions		19		—		—		19
Total liabilities	$	22	$	—	$	3	$	19

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2015		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Foreign currency hedges	$	10	$	—	$	10	$	—
Interest rate hedges		46		—		46		—
Available-for-sale securities		5,162		14		5,148		—
Total assets	$	5,218	$	14	$	5,204	$	—
Liabilities
Foreign currency hedges	$	2	$	—	$	2	$	—
Contingent payments related to acquisitions		20		—		—		20
Total liabilities	$	22	$	—	$	2	$	20

As of December 31, 2016, cash and equivalents of $2.8 billion included money market funds of approximately $1.4 billion, which would be considered Level 2 in the fair value hierarchy.

For assets that are measured using quoted prices in active markets, the fair value is the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The investment in the Retained Shares of $5.1 billion as of December 31, 2015 was categorized as a Level 2 security as these securities were not registered as of that date. The value of this investment is based on Baxalta’s common stock price as of December 31, 2015, which represents an identical equity instrument registered under the Securities Act of 1933, as amended. The company disposed of the remainder of its Retained Shares in Baxalta in the first half of 2016, as described below. The majority of the derivatives entered into by the company are valued using internal valuation techniques as no quoted market prices exist for such instruments. The principal techniques used to value these instruments are discounted cash flow and Black-Scholes models. The key inputs are considered observable and vary depending on the type of derivative, and include contractual terms, interest rate yield curves, foreign exchange rates and volatility.

Contingent payments related to acquisitions consist of commercial milestone payments and sales-based payments, and are valued using discounted cash flow techniques. The fair value of commercial milestone payments reflects management’s expectations of probability of payment, and increases as the probability of payment increases or expectation of timing of payments is accelerated. The fair value of sales-based payments is based upon probability-weighted future revenue estimates, and increases as revenue estimates increase, probability weighting of higher revenue scenarios increase or expectation of timing of payment is accelerated.

The following table is a reconciliation of the fair value measurements that use significant unobservable inputs (Level 3), which consist of contingent payments related to acquisitions.

(in millions)	Contingent payments
Fair value as of December 31, 2014	$	45
Additions		—
Payments		(3	)
Net gains recognized in earnings		(22	)
Fair value as of December 31, 2015		20
Additions		—
Payments		(1	)
Net gains recognized in earnings		—
Fair value as of December 31, 2016	$	19

The following table provides information relating to the company’s investments in available-for-sale equity securities.

(in millions)		Amortized cost				Unrealized gains				Unrealized losses				Fair value
December 31, 2016		$	13			$	—			$	4			$	9
December 31, 2015		$	732			$	4,430			$	—			$	5,162

Book Values and Fair Values of Financial Instruments

In addition to the financial instruments that the company is required to recognize at fair value in the consolidated balance sheets, the company has certain financial instruments that are recognized at historical cost or some basis other than fair value. For these financial instruments, the following table provides the values recognized in the consolidated balance sheets and the approximate fair values.

	Book values				Approximate fair values
as of December 31 (in millions)	2016		2015		2016		2015
Assets
Investments	$	31	$	21	$	31	$	21
Liabilities
Short-term debt		—		1,775		—		1,775
Current maturities of long-term debt and lease obligations		3		810		3		818
Long-term debt and lease obligations		2,779		3,922		2,756		4,077

The following table summarizes the bases used to measure the approximate fair value of the financial instruments as of December 31, 2016 and 2015.

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2016		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Investments	$	31	$	—	$	—	$	31
Total assets	$	31	$	—	$	—	$	31
Liabilities
Short-term debt	$	—	$	—	$	—	$	—
Current maturities of long-term debt and lease obligations		3		—		3		—
Long-term debt and lease obligations		2,756		—		2,756		—
Total liabilities	$	2,759	$	—	$	2,759	$	—

			Basis of fair value measurement
(in millions)	Balance as of December 31, 2015		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets
Investments	$	21	$	—	$	2	$	19
Total assets	$	21	$	—	$	2	$	19
Liabilities
Short-term debt	$	1,775	$	—	$	1,775	$	—
Current maturities of long-term debt and lease obligations		818		—		818		—
Long-term debt and lease obligations		4,077		—		4,077		—
Total liabilities	$	6,670	$	—	$	6,670	$	—

Investments in 2016 and 2015 include certain cost method investments and held-to-maturity debt securities.

The fair value of held-to-maturity debt securities is calculated using a discounted cash flow model that incorporates observable inputs, including interest rate yields, which represents a Level 2 basis of fair value measurement. In determining the fair value of cost method investments, the company takes into consideration recent transactions, as well as the financial information of the investee, which represents a Level 3 basis of fair value measurement.

The estimated fair values of current and long-term debt were computed by multiplying price by the notional amount of the respective debt instrument. Price is calculated using the stated terms of the respective debt instrument and yield curves commensurate with the company’s credit risk. The carrying values of the other financial instruments approximate their fair values due to the short-term maturities of most of these assets and liabilities.

In 2016, the company recorded net $4.4 billion of realized gains within other expense (income), net related to exchanges of available-for-sale equity securities, which represented gains from the Retained Shares transactions. On May 6, 2016, Baxter made a voluntary non-cash contribution of 17,145,570 Retained Shares to the company’s U.S. pension fund. The company recorded $611 million of realized gains within other (income) expense, net related to the contribution of Retained Shares. On May 26, 2016, Baxter completed an exchange of 13,360,527 Retained Shares for 11,526,638 outstanding shares of Baxter common stock. The company recorded $537 million of realized gains within other (income) expense, net related to the exchange of the Retained Shares. The company held no shares of Baxalta as of December 31, 2016. Refer to the debt-for-equity exchange section in Note 8 for discussion related to the first quarter 2016 Retained Shares transactions. In 2015, the company recorded income of $38 million, in other expense (income), net related to equity method investments, which primarily represented gains from the sale of certain investments as well as distributions from funds that sold portfolio companies.

NOTE 11

COMMITMENTS AND CONTINGENCIES

Collaborative and Other Arrangements

Refer to Note 5 for information regarding the company’s unfunded contingent payments associated with collaborative and other arrangements.

Indemnifications

During the normal course of business, Baxter makes indemnities, commitments and guarantees pursuant to which the company may be required to make payments related to specific transactions. Indemnifications include: (i) intellectual property indemnities to customers in connection with the use, sales or license of products and services; (ii) indemnities to customers in connection with losses incurred while performing services on their premises; (iii) indemnities to vendors and service providers pertaining to claims based on negligence or willful misconduct; (iv) indemnities involving the representations and warranties in certain contracts; (v) contractual indemnities related to the separation and distribution as set forth in certain of the agreements entered into in connection with such transactions (including the separation and distribution agreement and the tax matters agreement); and (vi) contractual indemnities for its directors and certain of its executive officers for services provided to or at the request of Baxter. In addition, under Baxter’s Amended and Restated Certificate of Incorporation, and consistent with Delaware General Corporation Law, the company has agreed to indemnify its directors and officers for certain losses and expenses upon the occurrence of certain prescribed events. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum potential for future payments that the company could be obligated to make. To help address some of these risks, the company maintains various insurance coverages. Based on historical experience and evaluation of the agreements, the company does not believe that any significant payments related to its indemnities will occur, and therefore the company has not recorded any associated liabilities.

Legal Contingencies

Refer to Note 16 for a discussion of the company’s legal contingencies.

NOTE 12

SHAREHOLDERS’ EQUITY

Stock-Based Compensation

The company’s stock-based compensation generally includes stock options, restricted stock units (RSUs), performance share units (PSUs) and purchases under the company’s employee stock purchase plan. Shares issued relating to the company’s stock-based plans are generally issued out of treasury stock.

Approved in 2015, the Baxter International Inc. 2015 Incentive Plan provided for 35 million additional shares of common stock available for issuance with respect to awards for participants. As of December 31, 2016, approximately 46 million authorized shares are available for future awards under the company’s stock-based compensation plans.

Stock Compensation Expense

Stock compensation expense was $115 million, $126 million and $126 million in 2016, 2015 and 2014, respectively. The related tax benefit recognized was $34 million in 2016, $38 million in 2015 and $41 million in 2014.

Stock compensation expense is recorded at the corporate level and is not allocated to the segments. Approximately 70% of stock compensation expense is classified in marketing and administrative expenses, with the remainder classified in cost of sales and R&D expenses. Costs capitalized in the consolidated balance sheets at December 31, 2016 and 2015 were not material.

Stock compensation expense is based on awards expected to vest, and therefore has been reduced by estimated forfeitures.

Stock Options

Stock options are granted to employees and non-employee directors with exercise prices equal to 100% of the market value on the date of grant. Stock options granted to employees generally vest in one-third increments over a three-year period. Stock options granted to non-employee directors generally cliff-vest one year from the grant date. Stock options typically have a contractual term of

10 years. The grant-date fair value, adjusted for estimated forfeitures, is recognized as expense on a straight-line basis over the substantive vesting period.

The fair value of stock options is determined using the Black-Scholes model. The weighted-average assumptions used in estimating the fair value of stock options granted during each year, along with the weighted-average grant-date fair values, were as follows:

years ended December 31	2016			2015			2014
Expected volatility		20	%		20	%		24	%
Expected life (in years)		5.5			5.5			5.5
Risk-free interest rate		1.4	%		1.7	%		1.7	%
Dividend yield		1.2	%		2.9	%		2.8	%
Fair value per stock option	$	7		$	9		$	12

The following table summarizes stock option activity for the year ended December 31, 2016 and the outstanding stock options as of December 31, 2016.

(options and aggregate intrinsic values in thousands)		Weighted- average exercise price			Aggregate intrinsic value
Outstanding as of January 1, 2016	35,799	$	34.16
Granted	6,939	$	39.70
Exercised	(7,705)	$	31.50
Forfeited	(1,831)	$	38.14
Expired	(126)	$	32.87
Outstanding as of December 31, 2016	33,076	$	35.73	6.2	$	284,821
Vested or expected to vest as of December 31, 2016	32,502	$	35.67	6.2	$	281,976
Exercisable as of December 31, 2016	18,707	$	33.71	4.7	$	198,873

The aggregate intrinsic value in the table above represents the difference between the exercise price and the company’s closing stock price on the last trading day of the year. The total intrinsic value of options exercised in 2016, 2015 and 2014 were $162 million, $43 million and $114 million, respectively.

As of December 31, 2016, $45 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over a weighted-average period of approximately 1.3 years.

RSUs

RSUs are granted to employees and non-employee directors. RSUs granted to employees generally vest in one-third increments over a three-year period. RSUs granted to non-employee directors generally cliff-vest one year from the grant date. The grant-date fair value, adjusted for estimated forfeitures, is recognized as expense on a straight-line basis over the substantive vesting period. The fair value of RSUs is determined based on the number of shares granted and the close price of the company’s common stock on the date of grant.

The following table summarizes nonvested RSU activity for the year ended December 31, 2016.

(share units in thousands)		Weighted- average grant-date fair value
Nonvested RSUs as of January 1, 2016	3,078	$	37.62
Granted	1,229	$	40.32
Vested	(1,271)	$	23.14
Forfeited	(338)	$	33.20
Nonvested RSUs as of December 31, 2016	2,698	$	32.90

As of December 31, 2016 $49 million of unrecognized compensation cost related to RSUs is expected to be recognized as expense over a weighted-average period of approximately 1.4 years. The weighted-average grant-date fair value of RSUs in 2016, 2015 and 2014 was $40.32, $66.65 and $71.22, respectively. The fair value of RSUs vested in 2016, 2015 and 2014 was $50 million, $73 million and $62 million, respectively.

PSUs

The company’s annual equity awards stock compensation program for senior management includes the issuance of PSUs based on adjusted operating margin, ROIC, as well as market conditions. The vesting condition for adjusted operating margin or ROIC PSUs is set at the beginning of the year for each tranche of the award during the three-year service period. Compensation cost for the adjusted operating margin or ROIC PSUs is measured based on the fair value of the awards on the date that the specific vesting terms for each tranche of the award are established. The fair value of the awards is determined based on the quoted price of the company’s stock on the grant date for each tranche of the award. The compensation cost for adjusted operating margin or ROIC PSUs is adjusted at each reporting date to reflect the estimated probability of achieving the vesting condition.

The fair value for PSUs based on market conditions is determined using a Monte Carlo model. The assumptions used in estimating the fair value of these PSUs granted during the period, along with the grant-date fair values, were as follows:

years ended December 31	2016		2015		2014
Baxter volatility		20%		19%		20%
Peer group volatility	17%-51%		16%-38%		13%-58%
Correlation of returns	0.22-0.73		0.24-0.55		0.23-0.66
Risk-free interest rate		1.0%		1.1%		0.7%
Fair value per PSU	$	51	$	46	$	57

Unrecognized compensation cost related to all unvested PSUs of $9 million at December 31, 2016 is expected to be recognized as expense over a weighted-average period of 1.9 years.

The following table summarizes nonvested PSU activity for the year ended December 31, 2016.

(share units in thousands)			Weighted- average grant-date fair value
Nonvested PSUs as of January 1, 2016	300		$	36.11
Granted	282		$	45.83
Vested	(260	)	$	34.42
Forfeited	(44	)	$	42.27
Nonvested PSUs as of December 31, 2016	278		$	46.82

Realized Excess Income Tax Benefits and the Impact on the Statements of Cash Flows

Realized excess tax benefits associated with stock compensation are presented in the consolidated statements of cash flows as an outflow within the operating section and an inflow within the financing section. Realized excess tax benefits from stock-based compensation related to continuing operations were $39 million, $7 million and $15 million in 2016, 2015 and 2014, respectively.

Employee Stock Purchase Plan

Nearly all employees are eligible to participate in the company’s employee stock purchase plan. The employee purchase price is 85% of the closing market price on the purchase date.

The Baxter International Inc. Employee Stock Purchase Plan provides for 10 million shares of common stock available for issuance to eligible participants, of which approximately five million shares were available for future purchases as of December 31, 2016.

During 2016, 2015, and 2014, the company issued approximately 1.0 million, 1.1 million and 0.8 million shares, respectively, under the employee stock purchase plan. The number of shares under subscription at December 31, 2016 totaled approximately 1.0 million.

Cash Dividends

Total cash dividends declared per common share for 2016, 2015, and 2014 were $0.51, $1.27 and $2.05, respectively.

A quarterly dividend of $0.115 per share ($0.46 on an annualized basis) was declared in February 2016 and was paid in April 2016. Quarterly dividends of $0.13 per share ($0.52 on an annualized basis) were declared in May and August of 2016 and were paid in June and October of 2016, respectively. Baxter’s board of directors declared a quarterly dividend of $0.13 per share in November of 2016, which was paid in January of 2017.

Stock Repurchase Programs

As authorized by the board of directors, the company repurchases its stock depending on the company’s cash flows, net debt level and market conditions. The company repurchased 6.3 million shares for $287 million in cash in 2016 and 8 million shares for $600 million in cash in 2014. The company did not repurchase shares in 2015. In July 2012, the board of directors authorized the repurchase of up to $2 billion of the company’s common stock. The board of directors increased this authority by an additional $1.5 billion in November 2016. $1.7 billion remained available as of December 31, 2016.

NOTE 13

RETIREMENT AND OTHER BENEFIT PROGRAMS

The company sponsors a number of qualified and nonqualified pension plans for eligible employees. The company also sponsors certain unfunded contributory healthcare and life insurance benefits for substantially all domestic retired employees. Newly hired employees in the United States and Puerto Rico are not eligible to participate in the pension plans but receive a higher level of company contributions in the defined contribution plans.

In the second quarter of 2016, the company made a $706 million voluntary, non-cash contribution to the qualified U.S. pension plan using Retained Shares. Refer to Note 2 for additional information regarding Retained Share transactions.

In the second quarter of 2015, in connection with the transfer of liabilities and assets from a combined Baxter pension or Other Postemployment Benefits (OPEB) plan to a newly created Baxalta pension or OPEB plan, the company remeasured pension and OPEB liabilities and assets for several of its plans. The remeasurement resulted in a reduction to pension and OPEB obligations of $220 million, with an offset to AOCI.

In July 2014, a change was made to postemployment medical benefits for retirees who are age 65 or older to provide eligible retirees and their dependents a subsidy to be utilized on a medical insurance exchange. This change was accounted for as a significant plan amendment. Accordingly, the postemployment benefit obligation was remeasured using a discount rate of 4.30% as of July 31, 2014. Prior to the effect of the separation, the plan amendment resulted in a reduction to the postemployment benefit obligation of $124 million, which was partially offset by a $44 million actuarial loss for the change in discount rate. The corresponding $80 million recognized in AOCI will be amortized as a reduction to net periodic benefit cost over approximately 11 years.

Reconciliation of Pension and OPEB Plan Obligations, Assets and Funded Status

The benefit plan information in the table below pertains to all of the company’s pension and OPEB plans, both in the United States and in other countries.

	Pension benefits						OPEB
as of and for the years ended December 31 (in millions)	2016			2015			2016			2015
Benefit obligations
Beginning of period	$	5,423		$	6,331		$	266		$	551
Service cost		93			128			2			4
Interest cost		183			211			8			14
Participant contributions		5			7			—			—
Actuarial (gain)/loss		298			(105	)		10			(261	)
Benefit payments		(234	)		(214	)		(20	)		(21	)
Settlements		(6	)		(3	)		—			—
Plan amendments		—			(2	)		(23	)		—
Separation of Baxalta		—			(821	)		—			(21	)
Foreign exchange and other		(45	)		(109	)		—			—
End of period		5,717			5,423			243			266
Fair value of plan assets
Beginning of period		3,698			4,197			—			—
Actual return on plan assets		309			(41	)		—			—
Employer contributions		752			157			20			21
Participant contributions		5			7			—			—
Benefit payments		(234	)		(214	)		(20	)		(21	)
Settlements		(6	)		(3	)		—			—
Separation of Baxalta		—			(347	)		—			—
Foreign exchange and other		(23	)		(58	)		—			—
End of period		4,501			3,698			—			—
Funded status at December 31	$	(1,216	)	$	(1,725	)	$	(243	)	$	(266	)
Amounts recognized in the consolidated balance sheets
Noncurrent asset	$	42		$	47		$	—		$	—
Current liability		(23	)		(22	)		(19	)		(19	)
Noncurrent liability		(1,235	)		(1,750	)		(224	)		(247	)
Net liability recognized at December 31	$	(1,216	)	$	(1,725	)	$	(243	)	$	(266	)

Accumulated Benefit Obligation Information

The pension obligation information in the table above represents the projected benefit obligation (PBO). The PBO incorporates assumptions relating to future compensation levels. The accumulated benefit obligation (ABO) is the same as the PBO except that it includes no assumptions relating to future compensation levels. The ABO for all of the company’s pension plans was $5.4 billion and $5.1 billion at the 2016 and 2015 measurement dates, respectively.

The information in the funded status table above represents the totals for all of the company’s pension plans. The following table is information relating to the individual plans in the funded status table above that have an ABO in excess of plan assets.

as of December 31 (in millions)		2016				2015
ABO		$	5,153			$	4,855
Fair value of plan assets			4,190				3,374

The following table is information relating to the individual plans in the funded status table above that have a PBO in excess of plan assets (many of which also have an ABO in excess of assets, and are therefore also included in the table directly above).

as of December 31 (in millions)		2016				2015
PBO		$	5,523			$	5,244
Fair value of plan assets			4,265				3,472

Expected Net Pension and OPEB Plan Payments for the Next 10 Years

(in millions)	Pension benefits		OPEB
2017	$	237	$	19
2018		246		20
2019		261		19
2020		270		18
2021		282		18
2022 through 2026		1,566		78
Total expected net benefit payments for next 10 years	$	2,862	$	172

The expected net benefit payments above reflect the company’s share of the total net benefits expected to be paid from the plans’ assets (for funded plans) or from the company’s assets (for unfunded plans). The federal subsidies relating to the Medicare Prescription Drug, Improvement and Modernization Act are not expected to be significant.

Amounts Recognized in AOCI

The pension and OPEB plans’ gains or losses, prior service costs or credits, and transition assets or obligations not yet recognized in net periodic benefit cost are recognized on a net-of-tax basis in AOCI and will be amortized from AOCI to net periodic benefit cost in the future. The company utilizes the average future working lifetime as the amortization period for prior service.

The following table is a summary of the pre-tax losses included in AOCI at December 31, 2016 and December 31, 2015.

(in millions)	Pension benefits			OPEB
Actuarial loss (gain)	$	1,885		$	(89	)
Prior service credit and transition obligation		(5	)		(103	)
Total pre-tax loss recognized in AOCI at December 31, 2016	$	1,880		$	(192	)
Actuarial loss (gain)	$	1,762		$	(107	)
Prior service credit and transition obligation		(5	)		(94	)
Total pre-tax loss recognized in AOCI at December 31, 2015	$	1,757		$	(201	)

Refer to Note 14 for the net-of-tax balances included in AOCI as of each of the year-end dates. The following table is a summary of the net-of-tax amounts recorded in OCI relating to pension and OPEB plans.

years ended December 31 (in millions)	2016			2015		2014
Gain (loss) arising during the year, net of tax expense (benefit) of ($72) in 2016, $44 in 2015 and ($240) in 2014	$	(191	)	$	45	$	(494	)
Distribution to Baxalta, net of tax expense of $73		—			198		—
Amortization of loss to earnings, net of tax expense of $36 in 2016, $61 in 2015 and $47 in 2014		94			120		94
Pension and other employee benefits (loss) gain	$	(97	)	$	363	$	(400	)

In 2016 and 2015, OCI activity for pension and OPEB plans was primarily related to actuarial gains and losses. In 2014, OCI activity for pension and OPEB plans was related to actuarial losses as well as the OPEB plan amendment referenced above.

Amounts Expected to be Amortized from AOCI to Net Periodic Benefit Cost in 2017

With respect to the AOCI balance at December 31, 2016, the following table is a summary of the pre-tax amounts expected to be amortized to net periodic benefit cost in 2017.

(in millions)	Pension benefits		OPEB
Actuarial loss/(gain)	$	162	$	(11	)
Prior service credit and transition obligation		—		(15	)
Total pre-tax amount expected to be amortized from AOCI to net pension and OPEB cost in 2017	$	162	$	(26	)

Net Periodic Benefit Cost – Continuing Operations

years ended December 31 (in millions)	2016			2015			2014
Pension benefits
Service cost	$	93		$	128		$	130
Interest cost		183			211			242
Expected return on plan assets		(298	)		(270	)		(269	)
Amortization of net losses and other deferred amounts		149			192			144
Settlement losses		2			2			1
Net pension costs related to discontinued operations		—			(43	)		(55	)
Net periodic pension benefit cost	$	129		$	220		$	193
OPEB
Service cost	$	2		$	4		$	5
Interest cost		8			14			25
Amortization of net loss and prior service credit		(19	)		(11	)		(3	)
Curtailment		(4	)		—			—
Net OPEB costs related to discontinued operations		—			—			(1	)
Net periodic OPEB cost	$	(13	)	$	7		$	26

Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date

	Pension benefits						OPEB
	2016			2015			2016			2015
Discount rate
U.S. and Puerto Rico plans		4.09	%		4.36	%		3.89	%		4.12	%
International plans		2.05	%		2.60	%	n/a			n/a
Rate of compensation increase
U.S. and Puerto Rico plans		3.75	%		3.75	%	n/a			n/a
International plans		3.08	%		3.37	%	n/a			n/a
Annual rate of increase in the per-capita cost	n/a			n/a				6.25	%		6.50	%
Rate decreased to	n/a			n/a				5.00	%		5.00	%
by the year ended	n/a			n/a			2022			2022

The assumptions above, which were used in calculating the December 31, 2016 measurement date benefit obligations, will be used in the calculation of net periodic benefit cost in 2017.

Effective January 1, 2016, the company changed its approach used to calculate the service and interest components of net periodic benefit cost. Previously, the company calculated the service and interest components utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation. The company has elected an alternative approach that utilizes a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to their underlying projected cash flows. The company believes this approach provides a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows and their corresponding spot rates. The company accounted for this change prospectively as a change in estimate.

Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost

	Pension benefits									OPEB
	2016			2015			2014			2016			2015			2014
Discount rate
U.S. and Puerto Rico plans		4.36	%		4.00	%		4.85	%		4.12	%		3.95	%		4.90	%
International plans		2.60	%		2.26	%		3.41	%	n/a			n/a			n/a
Expected return on plan assets
U.S. and Puerto Rico plans		7.00	%		7.25	%		7.50	%	n/a			n/a			n/a
International plans		6.07	%		6.20	%		6.02	%	n/a			n/a			n/a
Rate of compensation increase
U.S. and Puerto Rico plans		3.75	%		3.76	%		3.80	%	n/a			n/a			n/a
International plans		3.37	%		3.33	%		3.29	%	n/a			n/a			n/a
Annual rate of increase in the per-capita cost	n/a			n/a			n/a				6.50	%		6.00	%		6.25	%
Rate decreased to	n/a			n/a			n/a				5.00	%		5.00	%		5.00	%
by the year ended	n/a			n/a			n/a			2022			2019			2019

The 2015 actuarial gain for the OPEB plan was primarily related to adjustments to the assumptions for retirees who are age 65 and older and receive a subsidy to be utilized on a medical insurance exchange.

The company establishes the expected return on plan assets assumption primarily based on a review of historical compound average asset returns, both company-specific and relating to the broad market (based on the company’s asset allocation), as well as an analysis of current market and economic information and future expectations. The company plans to use a 6.50% assumption for its U.S. and Puerto Rico plans for 2017.

Effect of a One-Percent Change in Assumed Healthcare Cost Trend Rate on the OPEB Plan

	One percent increase				One percent decrease
years ended December 31 (in millions)	2016		2015		2016		2015
Effect on total of service and interest cost components of OPEB cost	$	—	$	1	$	—	$	(1	)
Effect on OPEB obligation	$	—	$	1	$	—	$	(4	)

Pension Plan Assets

An investment committee of members of senior management is responsible for supervising, monitoring and evaluating the invested assets of the company’s funded pension plans. The investment committee, which meets at least quarterly, abides by documented policies and procedures relating to investment goals, targeted asset allocations, risk management practices, allowable and prohibited investment holdings, diversification, use of derivatives, the relationship between plan assets and benefit obligations, and other relevant factors and considerations.

The investment committee’s policies and procedures include the following:

	•	Ability to pay all benefits when due;

	•	Targeted long-term performance expectations relative to applicable market indices, such as Russell, MSCI EAFE, and other indices;

	•	Targeted asset allocation percentage ranges (summarized below), and periodic reviews of these allocations;

	•	Diversification of assets among third-party investment managers, and by geography, industry, stage of business cycle and other measures;

	•	Specified investment holding and transaction prohibitions (for example, private placements or other restricted securities, securities that are not traded in a sufficiently active market, short sales, certain derivatives, commodities and margin transactions);

	•	Specified portfolio percentage limits on holdings in a single corporate or other entity (generally 5% at time of purchase, except for holdings in U.S. government or agency securities);

	•	Specified average credit quality for the fixed-income securities portfolio (at least A- by Standard & Poor’s or A3 by Moody’s);

	•	Specified portfolio percentage limits on foreign holdings; and

	•	Periodic monitoring of investment manager performance and adherence to the investment committee’s policies.

Plan assets are invested using a total return investment approach whereby a mix of equity securities, debt securities and other investments are used to preserve asset values, diversify risk and exceed the planned benchmark investment return. Investment strategies and asset allocations are based on consideration of plan liabilities, the plans’ funded status and other factors, such as the plans’ demographics and liability durations. Investment performance is reviewed by the investment committee on a quarterly basis and asset allocations are reviewed at least annually.

Plan assets are managed in a balanced portfolio comprised of two major components: return-seeking investments and liability hedging investments. The target allocations for plan assets are 53% in return-seeking investments and 46% in liability hedging investments and other holdings. The documented policy includes an allocation range based on each individual investment type within the major components that allows for a variance from the target allocations of approximately two to five percentage points depending on the investment type. Return-seeking investments primarily include common stock of U.S. and international companies, common/collective trust funds, mutual funds, and partnership investments. Liability hedging investments and other holdings primarily include cash, money market funds with an original maturity of three months or less, U.S. and foreign government and governmental agency issues, corporate bonds, municipal securities, hedge funds, derivative contracts and asset-backed securities.

While the investment committee provides oversight over plan assets for U.S. and international plans, the summary above is specific to the plans in the United States. The plan assets for international plans are managed and allocated by the entities in each country, with input and oversight provided by the investment committee. The plan assets for the U.S. and international plans are included in the table below.

The following tables summarize the bases used to measure the pension plan assets and liabilities that are carried at fair value on a recurring basis.

				Basis of fair value measurement
(in millions)	Balance at December 31, 2016			Quoted prices in active markets for identical assets (Level 1)			Significant other observable inputs (Level 2)			Significant unobservable inputs (Level 3)		Measured at NAV
Assets
Fixed income securities
Cash and cash equivalents	$	443		$	16		$	427		$	—	$	—
U.S. government and government agency issues		457			—			457			—		—
Corporate bonds		850			13			837			—		—
Equity securities
Common stock:
Large cap		545			545			—			—		—
Mid cap		371			371			—			—		—
Small cap		94			94			—			—		—
Total common stock		1,010			1,010			—			—		—
Mutual funds		336			118			218			—		—
Common/collective trust funds		900			—			143			6		751
Partnership investments		388			—			—			—		388
Other holdings		117			10			97			10		—
Collateral held on loaned securities		126			—			126			—		—
Liabilities
Collateral to be paid on loaned securities		(126	)		(37	)		(89	)		—		—
Fair value of pension plan assets	$	4,501		$	1,130		$	2,216		$	16	$	1,139

				Basis of fair value measurement
(in millions)	Balance at December 31, 2015			Quoted prices in active markets for identical assets (Level 1)			Significant other observable inputs (Level 2)			Significant unobservable inputs (Level 3)		Measured at NAV
Assets
Fixed income securities
Cash and cash equivalents	$	166		$	32		$	134		$	—	$	—
U.S. government and government agency issues		347			—			347			—		—
Corporate bonds		632			—			632			—		—
Equity securities
Common stock:
Large cap		880			880			—			—		—
Mid cap		359			359			—			—		—
Small cap		111			111			—			—		—
Total common stock		1,350			1,350			—			—		—
Mutual funds		328			112			216			—		—
Common/collective trust funds		565			—			131			6		428
Partnership investments		209			—			—			—		209
Other holdings		101			4			95			2		—
Collateral held on loaned securities		208			—			208			—		—
Liabilities
Collateral to be paid on loaned securities		(208	)		(60	)		(148	)		—		—
Fair value of pension plan assets	$	3,698		$	1,438		$	1,615		$	8	$	637

The following table is a reconciliation of changes in fair value measurements that used significant unobservable inputs (Level 3).

(in millions)	Total		Common/collective trust funds		Other holdings
Balance at December 31, 2014	$	8	$	6	$	2
Actual return on plan assets still held at year end		—		—		—
Actual return on plan assets sold during the year		—		—		—
Purchases, sales and settlements		—		—		—
Balance at December 31, 2015		8		6		2
Actual return on plan assets still held at year end		—		—		—
Actual return on plan assets sold during the year		—		—		—
Purchases, sales and settlements		8		—		8
Balance at December 31, 2016	$	16	$	6	$	10

The assets and liabilities of the company’s pension plans are valued using the following valuation methods:

Investment category		Valuation methodology

Cash and cash equivalents		These largely consist of a short-term investment fund, U.S. Dollars and foreign currency. The fair value of the short-term investment fund is based on the net asset value

U.S. government and government agency issues		Values are based on reputable pricing vendors, who typically use pricing matrices or models that use observable inputs

Corporate bonds		Values are based on reputable pricing vendors, who typically use pricing matrices or models that use observable inputs

Common stock		Values are based on the closing prices on the valuation date in an active market on national and international stock exchanges

Mutual funds		Values are based on the net asset value of the units held in the respective fund which are obtained from national and international exchanges or based on the net asset value of the underlying assets of the fund provided by the fund manager

Common/collective trust funds		Values are based on the net asset value of the units held at year end

Partnership investments		Values are based on the estimated fair value of the participation by the company in the investment as determined by the general partner or investment manager of the respective partnership

Other holdings		The value of these assets vary by investment type, but primarily are determined by reputable pricing vendors, who use pricing matrices or models that use observable inputs

Collateral held on loaned securities		Values are based on the net asset value per unit of the fund in which the collateral is invested

Collateral to be paid on loaned securities		Values are based on the fair value of the underlying securities loaned on the valuation date

Expected Pension and OPEB Plan Funding

The company’s funding policy for its pension plans is to contribute amounts sufficient to meet legal funding requirements, plus any additional amounts that the company may determine to be appropriate considering the funded status of the plans, tax deductibility, the cash flows generated by the company, and other factors. Volatility in the global financial markets could have an unfavorable impact on future funding requirements. The company has no obligation to fund its principal plans in the United States in 2017. The company continually reassesses the amount and timing of any discretionary contributions. The company expects to make a contribution of at least $20 million to its Puerto Rico pension plan and at least a $40 million contribution to its foreign pension plans in 2017. The company expects to have net cash outflows relating to its OPEB plan of approximately $19 million in 2017.

The following table details the funded status percentage of the company’s pension plans as of December 31, 2016, including certain plans that are unfunded in accordance with the guidelines of the company’s funding policy outlined above.

	United States and Puerto Rico					International
as of December 31, 2016 (in millions)	Qualified plans			Nonqualified plan		Funded plans			Unfunded plans		Total
Fair value of plan assets	$	3,828		n/a		$	673		n/a		$	4,501
PBO		4,296		$	214		843		$	363		5,716
Funded status percentage		89	%	n/a			80	%	n/a			79	%

U.S. Defined Contribution Plan

Most U.S. employees are eligible to participate in a qualified defined contribution plan. Expense recognized by the company was $50 million in 2016, $46 million in 2015 and $54 million in 2014.

NOTE 14

ACCUMULATED OTHER COMPREHENSIVE INCOME

Comprehensive income includes all changes in shareholders’ equity that do not arise from transactions with stockholders, and consists of net income, CTA, pension and other employee benefits, unrealized gains and losses on cash flow hedges and unrealized gains and losses on available-for-sale equity securities. The following table is a net-of-tax summary of the changes in AOCI by component for the years ended December 31, 2016 and 2015.

(in millions)	CTA			Pension and other employee benefits			Hedging activities			Available- for-sale securities			Total
Gains (losses)
Balance as of December 31, 2015	$	(3,191	)	$	(1,064	)	$	7		$	4,472		$	224
Other comprehensive income before reclassifications		(247	)		(191	)		1			104			(333	)
Amounts reclassified from AOCI		—			94			(5	)		(4,536	)		(4,447	)
Net other comprehensive (loss) income		(247	)		(97	)		(4	)		(4,432	)		(4,780	)
Balance as of December 31, 2016	$	(3,438	)	$	(1,161	)	$	3		$	40		$	(4,556	)

(in millions)	CTA			Pension and other employee benefits			Hedging activities			Available- for-sale securities			Total
Gains (losses)
Balance as of December 31, 2014	$	(2,323	)	$	(1,427	)	$	34		$	66		$	(3,650	)
Other comprehensive income before reclassifications		(1,094	)		45			46			4,461			3,458
Amounts reclassified from AOCI		—			120			(31	)		(23	)		66
Net other comprehensive (loss) income		(1,094	)		165			15			4,438			3,524
Distribution to Baxalta		226			198			(42	)		(32	)		350
Balance as of December 31, 2015	$	(3,191	)	$	(1,064	)	$	7		$	4,472		$	224

The following table is a summary of the amounts reclassified from AOCI to net income during the years ended December 31, 2016 and 2015.

	Amounts reclassified from AOCI (a)
(in millions)	2016			2015			Location of impact in income statement
Amortization of pension and other employee benefits items
Actuarial losses and other(b)	$	(130	)	$	(181	)
		(130	)		(181	)	Total before tax
		36			61		Tax benefit
	$	(94	)	$	(120	)	Net of tax
Gains (losses) on hedging activities
Interest rate contracts	$	9		$	—		Other (income) expense, net
Foreign exchange contracts		(3	)		47		Cost of sales
		6			47		Total before tax
		(1	)		(16	)	Tax expense
	$	5		$	31		Net of tax
Available-for-sale securities
Gain on available-for-sale equity securities	$	4,536		$	38		Other (income) expense, net
		4,536			38		Total before tax
		—			(15	)	Tax benefit
	$	4,536		$	23		Net of tax
Total reclassification for the period	$	4,447		$	(66	)	Total net of tax

(a)	Amounts in parentheses indicate reductions to net income.

(b)	These AOCI components are included in the computation of net periodic benefit cost disclosed in Note 13.

Refer to Note 9 for additional information regarding hedging activity and Note 13 for additional information regarding the amortization of pension and other employee benefits items.

NOTE 15

INCOME TAXES

Income from Continuing Operations Before Income Tax Expense by Category

years ended December 31 (in millions)	2016		2015			2014
United States	$	3,906	$	(738	)	$	(803	)
International		1,048		1,166			1,293
Income from continuing operations before income taxes	$	4,954	$	428		$	490

Income Tax Expense Related to Continuing Operations

years ended December 31 (in millions)	2016			2015			2014
Current
United States
Federal	$	10		$	(251	)	$	(305	)
State and local		(3	)		(6	)		(44	)
International		282			345			398
Current income tax expense		289			88			49
Deferred
United States
Federal		(286	)		(9	)		63
State and local		3			(20	)		7
International		(18	)		(24	)		(86	)
Deferred income tax expense		(301	)		(53	)		(16	)
Income tax (benefit) expense	$	(12	)	$	35		$	33

Deferred Tax Assets and Liabilities

as of December 31 (in millions)	2016			2015
Deferred tax assets
Accrued expenses	$	377		$	389
Retirement benefits		411			352
Tax credits and net operating losses		747			547
Valuation allowances		(150	)		(135	)
Total deferred tax assets		1,385			1,153
Deferred tax liabilities
Subsidiaries’ unremitted earnings		145			147
Asset basis differences		704			847
Total deferred tax liabilities		849			994
Net deferred tax asset	$	536		$	159

At December 31, 2016, the company had U.S. operating loss carryforwards totaling $887 million and tax credit carryforwards totaling $332 million. The U.S. operating loss carryforwards expire between 2018 and 2036 and the tax credits expire between 2017 and 2034. At December 31, 2016, the company had foreign operating loss carryforwards totaling $1.4 billion and foreign tax credit carryforwards totaling $48 million. Of these foreign amounts, $38 million expires in 2017, $18 million expires in 2018, $20 million expires in 2019, $41 million expires in 2020, $28 million expires in 2021, $293 million expires after 2021 and $1 billion has no expiration date. Realization of these operating loss and tax credit carryforwards depends on generating sufficient taxable income in future periods. A valuation allowance of $150 million and $135 million was recorded at December 31, 2016 and 2015, respectively, to reduce the deferred tax assets associated with net operating loss and tax credit carryforwards, because the company does not believe it is more likely than not that these assets will be fully realized prior to expiration. The company will continue to evaluate the need for additional valuation allowances and, as circumstances change, the valuation allowance may change.

Income Tax Expense Related to Continuing Operations Reconciliation

years ended December 31 (in millions)	2016			2015			2014
Income tax expense at U.S. statutory rate	$	1,734		$	150		$	174
Retained shares tax free exchange gains		(1,587	)		—			—
Tax incentives		(126	)		(133	)		(105	)
State and local taxes		1			(13	)		(24	)
Foreign tax expense (benefit)		5			11			(16	)
Valuation allowances		3			5			7
Contingent tax matters		(48	)		9			(18	)
Branded Prescription Drug Fee		1			1			4
Deferred tax charge on intangible intra-group transfers		13			14			14
R&D tax credit		(2	)		(4	)		(1	)
Puerto Rico excise tax credit		(5	)		(9	)		—
Other factors		(1	)		4			(2	)
Income tax (benefit) expense	$	(12	)	$	35		$	33

The company recognized deferred US income tax expense of $35 million during 2016 relating to 2016 earnings outside the United States that are not deemed indefinitely reinvested. The company continues to evaluate whether to indefinitely reinvest earnings in certain foreign jurisdictions as it continues to analyze the company’s global financial structure. Currently, management intends to continue to reinvest past earnings in several jurisdictions outside of the United States indefinitely, and therefore has not recognized U.S. income tax expense on these earnings. U.S. federal and state income taxes, net of applicable credits, on these foreign unremitted earnings from continuing operations of $9.3 billion as of December 31, 2016 would be approximately $2.6 billion. As of December 31, 2015 the foreign unremitted earnings from continuing operations and U.S. federal and state income tax amounts were $8.5 billion and $2.4 billion, respectively.

Effective Income Tax Rate — Continuing Operations

The effective income tax rate for continuing operations was $(0.2%) in 2016, 8.2% in 2015 and 6.7% in 2014. As detailed in the income tax expense reconciliation table above, the company’s effective tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.

Factors impacting the company’s effective tax rate in 2016 included tax-free net realized gains during the first and second quarter associated with the exchanges of Baxalta Retained Shares for the company’s debt and the company’s shares as well as tax-free net realized gains associated with the contribution of Baxalta Retained Shares to the company’s pension plan. Additionally, the income tax rate for 2016 was favorably impacted by tax benefits from partially settling an IRS (2008-2013) income tax audit, settling a German (2008-2011) income tax audit, resolution of uncertain tax positions related to the company’s former Turkish JV and other miscellaneous TP matters including partial settlement of interest expense deductions related to the company’s acquisition of Gambro.

Factors adversely impacting the company’s effective tax rate in 2015 included charges related to contingent tax matters primarily related to transfer pricing and separation of Baxalta as well as the need to record valuation allowances for some loss making entities. Partially offsetting the foregoing adverse factors was a benefit from reaching a settlement of the Puerto Rico excise tax matter as well as the retroactive reinstatement in December 2015 of the US R&D credit resulting from the Protecting Americans from Tax Hikes Act of 2015.

Factors impacting the company’s effective tax rate in 2014 included the favorable settlement of a portion of the company’s contingent tax matter related to operations in Turkey as well as a favorable shift of earnings from high to low tax jurisdictions compared to the prior period. Additionally, the effective tax rate was unfavorably impacted by increases in valuation allowances in respect of the tax benefit from losses that the company does not believe that it is more likely than not to realize and interest expense related to the company’s unrecognized tax benefits.

Unrecognized Tax Benefits

The company classifies interest and penalties associated with income taxes in the income tax expense line in the consolidated statements of income. Net interest and penalties recorded during 2016, 2015 and 2014 were $6 million, $3 million and $12 million, respectively. The liability recorded at December 31, 2016 and 2015 related to interest and penalties was $11 million and $56 million, respectively. The decrease in the liability for interest and penalties was due, in part, to settlement of audits in the United States,

Germany and Italy, as described in the Examination of Tax Returns section below. The total amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate is approximately $82 million.

The following table is a reconciliation of the company’s unrecognized tax benefits, including those related to discontinued operations for the years ended December 31, 2016, 2015 and 2014.

as of and for the years ended (in millions)	2016			2015			2014
Balance at beginning of the year	$	191		$	206		$	287
Increase associated with tax positions taken during the current year		7			24			41
Decrease associated with tax positions taken during a prior year		(31	)		(26	)		(27	)
Settlements		(75	)		(3	)		(82	)
Decrease associated with lapses in statutes of limitations		(10	)		(10	)		(13	)
Balance at end of the year	$	82		$	191		$	206

Of the gross unrecognized tax benefits, $74 million and $209 million were recognized as liabilities in the consolidated balance sheets as of December 31, 2016 and 2015, respectively. Baxter has recorded net indemnification receivables from Baxalta in the amount of $28 million and $93 million as of December 31, 2016 and 2015, respectively, related to the unrecognized tax benefits for which Baxter is the primary obligor but economically relate to Baxalta operations. Additionally, in the table above amounts related to 2015 included as a decrease a gross liability transferred to Baxalta in the amount of $10 million for which Baxalta is the primary obligor.

None of the positions included in the liability for uncertain tax positions related to tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility.

Tax Incentives

The company has received tax incentives in Puerto Rico, Switzerland, Dominican Republic, Costa Rica and certain other taxing jurisdictions outside the United States. The financial impact of the reductions as compared to the statutory tax rates is indicated in the income tax expense reconciliation table above. The tax reductions as compared to the local statutory rate favorably impacted earnings from continuing operations per diluted share by $0.23 in 2016, $0.24 in 2015 and $0.20 in 2014. The Puerto Rico grant provides that the company’s manufacturing operations are and will be partially exempt from local taxes until the year 2018.

Examinations of Tax Returns

During 2016, Baxter paid approximately $303 million to partially settle a U.S. federal income tax audit for the period 2008-2013. Additionally, the company settled a German income tax audit for the period 2008-2011 and settled an Italian audit for the period 2010-2012. As a result of these settlements, the company reduced its gross unrecognized tax benefits by $75 million. Pursuant to the tax matters agreement with Baxalta, Baxalta paid the company approximately $37 million related to its tax indemnity obligations in respect of its portion of the settled gross unrecognized tax benefits. See Note 2 for additional details regarding the separation of Baxalta.

As of December 31, 2016, Baxter had ongoing audits in the United States, Austria, Sweden and other jurisdictions. Baxter expects to reduce the amount of its liability for uncertain tax positions within the next 12 months by $10 million due principally to the resolution of transfer pricing disputes in several jurisdictions. While the final outcome of these matters is inherently uncertain, the company believes it has made adequate tax provisions for all years subject to examination.

NOTE 16

LEGAL PROCEEDINGS

Baxter is involved in product liability, patent, commercial, and other legal matters that arise in the normal course of the company’s business. The company records a liability when a loss is considered probable and the amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. As of December 31, 2016 and 2015, the company’s total recorded reserves with respect to legal matters were $53 million and $29 million, respectively, and the total related receivables were $10 million and $5 million, respectively.

Baxter has established reserves for certain of the matters discussed below. The company is not able to estimate the amount or range of any loss for certain contingencies for which there is no reserve or additional loss for matters already reserved. While the liability of the company in connection with the claims cannot be estimated and the resolution thereof in any reporting period could have a significant

impact on the company’s results of operations and cash flows for that period, the outcome of these legal proceedings is not expected to have a material adverse effect on the company’s consolidated financial position. While the company believes that it has valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and the company may incur material judgments or enter into material settlements of claims.

In addition to the matters described below, the company remains subject to the risk of future administrative and legal actions. With respect to governmental and regulatory matters, these actions may lead to product recalls, injunctions, and other restrictions on the company’s operations and monetary sanctions, including significant civil or criminal penalties. With respect to intellectual property, the company may be exposed to significant litigation concerning the scope of the company’s and others’ rights. Such litigation could result in a loss of patent protection or the ability to market products, which could lead to a significant loss of sales, or otherwise materially affect future results of operations.

General litigation

On July 31, 2015, Davita Healthcare Partners, Inc. filed suit against Baxter Healthcare Corporation in the District Court of the State of Colorado regarding an ongoing commercial dispute relating to the provision of peritoneal dialysis products. A bench trial concluded in third quarter 2016 and the parties are awaiting the court’s decision.

In November 2016, a purported antitrust class action complaint seeking monetary and injunctive relief was filed in the United States District Court for the Northern District of Illinois. The complaint alleges a conspiracy among manufacturers of IV solutions to restrict output and affect pricing in connection with a shortage of such solutions. Similar parallel actions subsequently were filed. In January 2017, a single consolidated complaint covering these matters was filed in the Northern District of Illinois. The New York Attorney General has requested that Baxter provide information regarding business practices in the IV saline industry. The company is cooperating with the New York Attorney General.

Other

In the fourth quarter of 2012, the company received two investigative demands from the United States Attorney for the Western District of North Carolina for information regarding its quality and manufacturing practices and procedures at its North Cove facility. In January 2017, the parties resolved this matter by entering into a deferred prosecution agreement and a civil settlement whereby the company agreed to pay approximately $18 million and implement certain enhanced compliance measures.

In December 2016, the company received a civil investigative demand from the Commercial Litigation Branch of the United States Department of Justice primarily relating to contingent discount arrangements for, and other promotion of, the company’s TISSEEL and ARTISS products. The company is cooperating in this matter.

NOTE 17

SEGMENT INFORMATION

Baxter’s two segments are strategic businesses that are managed separately as each business develops, manufactures and markets distinct products and services. The segments and a description of their products and services are as follows:

The Renal business provides products and services to treat end-stage renal disease, or irreversible kidney failure, along with other renal therapies. The Renal business offers a comprehensive portfolio to meet the needs of patients across the treatment continuum, including technologies and therapies for peritoneal dialysis (PD), hemodialysis (HD), continuous renal replacement therapy (CRRT) and additional dialysis services.

The Hospital Products business manufactures intravenous (IV) solutions and administration sets, premixed drugs and drug-reconstitution systems, oncology injectable drugs, IV nutrition products, infusion pumps, inhalation anesthetics and biosurgery products. The business also provides products and services related to pharmacy compounding, drug formulation and packaging technologies.

The company uses income from continuing operations before net interest expense, income tax expense, depreciation and amortization expense (Segment EBITDA), on a segment basis to make resource allocation decisions and assess the ongoing performance of the company’s business segments. Intersegment sales are eliminated in consolidation.

Certain items are maintained at Corporate and are not allocated to a segment. They primarily include most of the company’s debt and cash and equivalents and related net interest expense, foreign exchange fluctuations (principally relating to intercompany receivables, payables and loans denominated in a foreign currency) and the majority of the foreign currency hedging activities, corporate headquarters costs, stock compensation expense, nonstrategic investments and related income and expense, certain employee benefit plan costs as well as certain nonrecurring gains, losses, and other charges (such as business optimization, integration and separation-related costs, and asset impairments). Financial information for the company’s segments is as follows:

for the years ended December 31 (in millions)	2016		2015		2014
Net sales
Renal	$	3,855	$	3,789	$	4,172
Hospital Products		6,308		6,179		6,547
Total net sales	$	10,163	$	9,968	$	10,719
EBITDA
Renal	$	703	$	566	$	666
Hospital Products		2,273		1,998		2,237
Total segment EBITDA	$	2,976	$	2,564	$	2,903

(in millions)	2016		2015		2014
Total assets
Renal	$	4,315	$	4,609	$	4,928
Hospital Products		6,407		6,632		6,915
Total segment assets	$	10,722	$	11,241	$	11,843

The following table is a reconciliation of segment EBITDA to income from continuing operations before income taxes per the consolidated statements of income.

for the years ended December 31 (in millions)	2016			2015			2014
Total segment EBITDA	$	2,976		$	2,564		$	2,903
Reconciling items
Depreciation and amortization		(800	)		(759	)		(792	)
Stock compensation		(115	)		(126	)		(126	)
Net interest expense		(66	)		(126	)		(145	)
Restructuring charges, net		(285	)		(130	)		6
Certain foreign exchange fluctuations and hedging activities		34			197			37
Net realized gains on Retained Shares transactions		4,387			—			—
Net loss on debt extinguishment		(153	)		(130	)		—
Other Corporate items		(1,024	)		(1,062	)		(1,393	)
Income from continuing operations before income taxes	$	4,954		$	428		$	490

The following table is a reconciliation of segment assets to consolidated total assets per the consolidated balance sheets.

as of December 31 (in millions)	2016		2015		2014
Total segment assets	$	10,722	$	11,241	$	11,843
Cash and equivalents		2,801		2,213		2,925
Deferred income taxes		629		354		531
PP&E, net		805		932		1,039
Assets held for disposition		50		245		9,363
Other Corporate assets		539		5,977		437
Consolidated total assets	$	15,546	$	20,962	$	26,138

Geographic Information

Net sales are based on product shipment destination and assets are based on physical location.

years ended December 31 (in millions)	2016		2015		2014
Net sales
United States	$	4,259	$	4,001	$	3,999
Europe		2,697		2,774		3,257
Asia-Pacific		2,029		1,972		2,079
Latin America and Canada		1,178		1,221		1,384
Consolidated net sales	$	10,163	$	9,968	$	10,719

as of December 31 (in millions)	2016		2015		2014
PP&E, net
United States	$	1,751	$	1,746	$	1,625
Europe		1,166		1,298		1,466
Asia-Pacific		752		757		753
Latin America and Canada		620		585		590
Consolidated PP&E, net	$	4,289	$	4,386	$	4,434

Net Sales by Franchise

The following table represents net sales by commercial franchise.

years ended December 31	2016		2015		2014
Total Renal1	$	3,855	$	3,789	$	4,172
Fluid Systems2		2,300		2,106		2,129
Integrated Pharmacy Solutions3		2,245		2,297		2,535
Surgical Care4		1,321		1,323		1,373
Other5		442		453		510
Total Hospital Products	$	6,308	$	6,179	$	6,547

1	The Renal segment is presented as a separate commercial franchise and includes sales of the company’s PD, HD and CRRT.

2	Principally includes IV therapies, infusion pumps, and administration sets.

3	Includes sales of the company’s premixed and oncology drug platforms, nutrition products and pharmacy compounding services.

4	Includes sales of the company’s inhaled anesthesia products as well as biological products and medical devices used in surgical procedures for hemostasis, tissue sealing and adhesion prevention.

5	Principally includes sales from the company’s pharmaceutical partnering business.

NOTE 18

QUARTERLY FINANCIAL RESULTS AND MARKET FOR THE COMPANY’S STOCK (UNAUDITED)

years ended December 31 (in millions, except per share data)	First quarter			Second quarter		Third quarter			Fourth quarter		Full year
2016
Net sales	$	2,375		$	2,585	$	2,558		$	2,645	$	10,163
Gross margin1		965			972		1,071			1,102		4,110
Income from continuing operations1		3,387			1,212		127			240		4,966
Income from continuing operations per common share1
Basic		6.17			2.21		0.23			0.44		9.10
Diluted		6.13			2.19		0.23			0.44		9.01
(Loss) income from discontinued operations, net of tax		(7	)		—		3			3		(1	)
(Loss) income from discontinued operations per common share
Basic		(0.01	)		0.00		0.01			0.01		(0.01	)
Diluted		(0.01	)		0.00		0.01			0.00		0.00
Net income1		3,380			1,212		130			243		4,965
Net income per common share1
Basic		6.16			2.21		0.24			0.45		9.09
Diluted		6.12			2.19		0.24			0.44		9.01
Cash dividends declared per common share		0.115			0.13		0.13			0.13		0.505
Market price per common share
High		41.28			46.39		49.03			49.16		49.16
Low		34.76			41.31		45.09			43.63		34.76
2015
Net sales	$	2,403		$	2,475	$	2,487		$	2,603	$	9,968
Gross margin2		1,019			1,021		1,034			1,072		4,146
Income from continuing operations2		134			74		2			183		393
Income from continuing operations per common share2
Basic		0.25			0.14		0.00			0.33		0.72
Diluted		0.24			0.13		0.00			0.33		0.72
Income from discontinued operations, net of tax		296			258		(1	)		22		575
Income from discontinued operations per common share
Basic		0.54			0.47		0.00			0.04		1.06
Diluted		0.54			0.47		0.00			0.04		1.04
Net income2		430			332		1			205		968
Net income per common share2
Basic		0.79			0.61		0.00			0.37		1.78
Diluted		0.78			0.60		0.00			0.37		1.76
Cash dividends declared per common share		0.52			0.52		0.115			0.115		1.27
Market price per common share
High3		38.97			39.05		43.44			38.79		43.44
Low3		35.84			34.59		33.25			32.18		32.18

The first quarter of 2016 included benefits of $3.1 billion related to business optimization, separation-related costs, Retained Stake transactions, a loss on debt extinguishment, and product-related items. The second quarter of 2016 included benefits of $1.0 billion related to business optimization, separation-related costs, Retained Stake transactions, and asset impairment. The third quarter of 2016 included charges of $155 million related to business optimization, separation-related costs, a loss on debt extinguishment, and a tax matter. The fourth quarter of 2016 included charges of $47 million related to business optimization, separation-related costs, and reserve items and adjustments.

The first quarter of 2015 included charges of $29 million related to business optimization, Gambro integration costs, and separation-related costs. The second quarter of 2015 included benefits of $5 million related to business optimization, Gambro integration costs, separation-related costs, and tax and legal reserves. The third quarter of 2015 included charges of $191 million related to business optimization, Gambro integration costs, separation-related costs, a loss on debt extinguishment, and product-related items. The fourth quarter of 2015 included $17 million related to business optimization, Gambro integration costs, product-related items, separation-related costs, and reserve items and adjustments.

3	All stock prices for periods preceding the July 1, 2015 separation of Baxalta are adjusted to reflect the high or low adjusted closing price for the period.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Baxter International Inc.:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(1) present fairly, in all material respects, the financial position of Baxter International Inc. and its subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(2) of this Form 10-K presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Chicago, Illinois

February 23, 2017

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